Repo Experts Stumped: How Could Fed Hike Without Draining ANY Liquidity: "This Is A Market By Decree"
While it took the equity markets over 24 hours to wake up to the realization that the first Fed tightening in 9 years is actually just that, and that not only monetary conditions will progressively get more constrictive especially if the Fed is intent on 4 more hikes in 2016, but that P/E multiples will contract by at least 3% according to a still optimistic Goldman Sachs, something far more interesting happened in repo markets, where the consensus expectation was that the Fed's rate would be accompanied by a major liquidity drain via reverse repos.
Recall that two weeks ago we cited repo-market expert E.D. Skyrm who calculated that moving general collateral higher by 25bps would require the Fed draining up to $800 billion in liquidity: "In 2013 on my website, I calculated that QE2 moved Repo rates, on average, 2.7 basis points for every $100B in QE. So, one very rough estimate moved GC 8 basis points and the other 2.7 basis points per hundred billion. In order to move GC 25 basis points higher, in a very rough estimate, the Fed needs to drain between $310B and $800B in liquidity."
Then on Wednesday morning Citigroup opined that the liquidity drain could be substantially greater: "There will be a separate document from the NY Fed with details around the operational aspects of the liftoff. Of primary interest will be the size of the overnight reverse repo facility that the Fed will put in place to pull short rates higher. We don’t think it will be unlimited, but a size large enough that will keep short rates from falling below the 25bp floor – and the size could be as high as $1tn."
So what happened?
As we reported a little after 1:15pm on Thursday when the details of the Fed's first post-hike reverse repo operation were revealed, something very strange and unexpected happened: not only did the Fed not drain $1 trillion, or $800 billion, or even $310 billion, the Fed did not drain any incremental liquidity at all!
In fact, the $105 billion accepted in the Reverse Repo operation was just $3 billion more than the op conducted the day before, the last ZIRP operation.
How is this possible, and how could the Fed substantially tighten financial conditions without draining any liquidity?
The answer: having read the work of most repo analysts over the past 48 hours, the truth is that nobody really knows, however for perhaps the most curious attempt at an explanation we go back to Wedbush's repo-expert E.D. Skyrm, who is just as stumped but has proposed an entertaining version of what happened: market by decree. To wit:
The Fed didn't really drain any liquidity yesterday. They moved the IOER up to .50%, moved the RRP rate up to .25%, and the RRP volume
came in at $105 billion, only $3 billion more than the day before. Where was the draining? But interest rates moved up anyway to reflect the
tightening, without any fundamental change. Basically, the Fed decreed a rate tightening and the market moved rates higher.
Markets work in interesting ways sometimes. Why should the GC rate trade at .41% yesterday when it traded at .21% the week before? In
the Repo market, rates are often set by where traders believe rates should be. Then, rates move higher or lower with imbalances between
supply and demand throughout the day. Naturally, there are substitution effects as Repo rates change in relation to other market rates, but
fundamentals don't necessarily dictate why Repo rates trade at .40% compared to .45%.
I wonder how many economic interest rate models include "by decree" as a factor?
That is one of the better financial questions we have heard in a long time, and here is another: do assets trade "by decree" or merely reflecting the wishes of the Fed's trading desk which together with its arms-length HFT intermediaries such as Citadel, has become the dominant marginal price setter across all asset classes.
A logical question is if the Fed is indeed focused on tightening easy financial conditions (ref: the recent implosion of the junk bond bubble) then the market - with its complete liquidity preference indifference to a the 25 bps hike - just dared Yellen to hike again, and again, until finally hundreds of billions if not trillions in excess liquidity are drained.
Finally, if repo rates move "by decree", what about Treasury markets, or commodities, or stocks? And what happens when the Fed can no longer move markets "by decree"?
For now, however, the Fed's "plumb protection team" is happy.
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The truth leaks out slowly. The plumb protection team better get to work.
this portends a clear green light for a 7-10% move up in the sp over the next nine trading days.
if you buy or own those 3x xhorts etf etn's, you are better off ging the money to a charity, your kids, strippers. anything better than getting ripped year end.
Just BTFD
Good advice until it isn't
And don't forget the TBTF's. The Fed and the TBTF's between them control over 70% of ALL "Markets". And the TBTF's OWN (Literally) The Fed so are obviously setting Fed policy and will not, after an event, operate in any way which would counter the policies they have decreed. Quote there are no more marrkets, only interventions unquote. This is the same as "By decree".
brilliant
Tyler, missed an oppurtunity. Need to have a picture of plumber with his ass crack showing. But I guess, picture not real like our intrest rates.
And, like the Fed, he has exactly the wrong tools to work with. None of those wrenches is going to help him with 1-1/2" ABS drainline.
I noticed that too. He might be high from cement fumes.
You guys are cute, looking for reality when it is just a model, kind of like traders looking for fundamentals or something!
Thank you for stepping in
That thread would have descended into a yet another new form of surreal fantasy
Its that 'Savings Glut'. What Bernanke failed to mention is all the savings are held by billionaires and oligarchs. They are more interested in power and control than they are in being rich, or spending their money. Hence the desire to hold on to their money. That, and they have more than they could spend in a life time any way.
Inflation in yachts and hookers and quality cocaine. Inflation in 'dollar store' crap, ground beef, chicken wings, etc. Deflation in mid-end residential real estate and stuff the Middle Class used to be able to afford, like entertainment, and vacations.
Maybe it's just me, but the above market anomolies explained could be the reason why I have been told by high level bankers that a gold standard "will never work".
I guess "work" means a policy of white-collar crime and outright fraud, so ya, I totally agree.
The FED is the markets my friends. There are no free markets, only banker controlled proxies. It would be incredibly naive for anyone to think that the lack of liquidity removal wasn't planned or conspired.
Yep, I've been saying it for months... even years. There are no markets anymore because the Rule of Law is officially dead. It was buried in 2008. The Fed with their proxies have achieved what they wanted... defacto control of the world govts and world bond markets. They learned their lessons of 2008, and later the EU and PIIGS, and now the BRICS. By taking out the bond vigilantes, and having access to world printing presses, they have perpetuated the Ponzi.
This has all been by design. I predict the farce will continue for at least another year until the 2016 election shakes out. If Hitlery wins, it will be just more of the same, only worse as the Clinton Crime Syndicate simply entrenches the banker/lobbyist NWO with a compliant RINO congress. But if Trump or Cruz should somehow win and actually threaten the NWO, then the elites will implode everything to teach the masses to NEVER NEVER NEVER elect an outsider to threaten them EVER again. The next depression will actually be a series of never ending worsening black swan events, financial and military, all designed to distract the sheeple to prevent them from revolting against the elites. The result will be by design to totally overwhelm a Trump or Cruz prez, and force them to resign or be impeached. That's when the New Feudal World Order will be ushered in... on the back of the greatest crisis the world has ever seen. Plan accordingly.
"They moved the IOER up to .50%,"
The fed won't drain jack shit as long as they keep raising the rate they pay on it.
This really isn't that hard to understand. If your trading partner raises their price and you have no other vendor -- you get an immediate price increase.
All this really shows is the intra bank lending market is totally dominated by one bank -- yellin national. It's not some conspiracy or magic, it's just what is.
ZH readers already knew this. Bank reserves have been very high and not used in lending. Hence the huge slow down in velocity since the banking crisis.
SDShack - Sounds about right, a good theory anyways. But I dont think I need to be a seer to speculate this all ends at the end of the tunnel in WW3. Just from opinion on geopolitics, this looks like Mexican-Stand Off who is more corrupt is less important as hedging for to me seem like probabilities. I hope I am wrong but hedging best as I can to have basics and get more mentally tough.
How and why?? "this portends a clear green light for a 7-10% move up in the sp over the next nine trading days." Does anything ever portend a decline of any significance?
Now is a good time to Buy.
One MUST buy now or be priced out!!
Buy, Buy, Buy!!!
Ain't going to happen with oil gunning for $30. This market cannot levitate without higher oil but oil this low just forces more production by near bankrupt producers. As the oil sector is highly leveraged these small drops in price produce outsized weakness in the market.Oil was going down before the raise in rates and oil was going down after the hike. The trends are in place.
You mean that there wasnt a ton of money sitting around waiting to make a half of percent, I am shocked..... / Sarc... not sure how Tylers didnt understand that.
Monday should be marginally up, after that who knows
FOSFB
There is obviously enough money for everybody... everybody connected that is..
the rest of you slobs get back to work we will make sure you get a little bit don't worry.
My best guess... why would you fight the Fed when you know they could sop up that liquidity and force rates higher if they wanted to? You gonna keep trading in front of the steam roller at 25 bps when you know they could force it to 50 at any time?
Alternate explanation: The Fed and the major banks have their heads so far up eachothers asses you can't tell where one ends and the other begins anyway. They're one organism for all practical purposes.
Perhaps psychology for the moment. Perhaps the market is just choosing to value money at whatever the Fed tells them to regardless of money supply/demand imbalances.
But if Fed decrees can replace the need for open market operations, that should work both ways. Why did the Fed need to print money and buy trillions in bonds with it over the past 7 years to get rates down? Why couldn't the Fed instead just dictate lower rates?
Well the question is, is draining really necessary?
According to Bloomberg they did drain 105 billion
http://www.bloomberg.com/news/articles/2015-12-18/fed-raised-rates-witho...
That's what this article says,
"In fact, the $105 billion accepted in the Reverse Repo operation was just $3 billion more than the op conducted the day before, the last ZIRP operation."
Yeah I missed that. Downvote for meself.
The (new) mechanism the Fed is using to implement rate increases is to pay interest on excess reserves held at the Fed.
If this is currency conjured out of thin air, it is a positive gradient on the monetary base => inflationary.
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Wow. This is above my pay grade.
Somebody care to link up some articles for those of us who haven't interned at Goldman Sachs for several years, to explain some background on what and how and why the Fed would need to/have to, drain 'liquidity' and what that means, in layman's terms?
Whatever it is, I get the drift that it's not good and the casino rigging is still in full effect.
•?•
V-V
Because the FED cannot just "say" for something to be so, they have to actually "do" something physically (or on a computer screen) in order to move the market. Just as they were flooding the market with liquidity as they were lowering the rates, now they have to drain the liquidity as they do the reverse. http://www.zerohedge.com/news/2015-12-16/fed-reveals-rate-hike-plumbing-...
Thanks, altough the part about not having interned at GS is still pertinant for me. WHY do they have to do something rather than just decree it? One day's evidence seems to indicate they can decree it, just like when they print pretty pictures on paper and say it's money. If people accept it then at least for awhile it IS money. I suspect this is part of a ruse on the Fed's part to make people think that no actual liquidity will be harmed in this operation but it is way above my pay grade. I assume there are behind-the-scenes operations at work but that's only because I trust Tyler to know his stuff.
I think they just said intrest rates have gone up - For the plebs, but not actually in any way that it will affect the banks - except as an increase in the bottom line.
If they don't drain the liquidity, but say the rates have gone up, its simply the rates for us, and not them LOL. The illusion of confidence.
We have a winner!
Deadfred - I am no expert but if a bubble gets produced by lowered interest rates then the already wealthy leverage that bubble up which prices out the rest of the market participants but a tiny few. Why does this matter outside of it being corrupt? Eventually your country becomes just like Mexico. Why then in turn does this also matter? Because desperate people do desperate things like kidnap kids for ransom like in Mexico. In turn if I can afford bullet proof glass, guards, etc what does this matter? Now your own quality of life suffers, the prison you trapped others in now has become your home and the cost of security and worry outweighs the benefits of graft.
Its Six Degrees of seperation, you are your brothers keeper by evolutionary design. None of us are likely to be 100% altruistic and all of us imperfect. My intent of spreading information is because I dont want to live in a slum or create my own prison. See, self interest can work if thought out to logical conclusion. And at the rate of business these days blowback happens within the liefspan of those that initiate the looting.
Lets say your ultra rich politician or banker (same thing these days). Having a bunker prepared means what? If nukes go off such may survive for a couple of years but then what? If one fled to New Zealand would the Chinese leave you alone?
So back to my original thought, bubbles must be pricked but what would have been better is if we didnt have a business model in banking that creates them for personal gain at the expense of the majority. This doesnt touch into moral hazard such as temporary beneficiaries thinking they are genius and having bad attitudes multiplying inneficiencis from the head down, until a country cannot operate.
The children of the ultra wealthy do not get kidnapped. They have an army of bodyguards and live in gated communities.
It is the upper middle class that are tageted. The children of doctors, engineers, and small business owners will be the targets.
I think I have this right. A pawn shop analogy works pretty good.
Suppose Pawn Shop Alpha bought some gold coins from a customer. Pawn Shop Alpha now has an asset (coin), but they don't have much cash anymore (liquidity). If Pawn Shop Alpha had a need for cash (regulatory, a really good deal walks in the door, etc), Pawn Shop Alpha heads over to Pawn Shop Fed and gives them the gold coin in exchange for cash, just like a pawn, and promises to come back and reverse the transaction, just like a pawn.
This is a "repurchase agreement" from the Pawn Shop Fed perspective. This adds liquidity to the system and interest rates go down because there is more money sloshing around. As ZH has noted, all this cash the fed shoved into the system is chasing stocks and high yield bonds, screwing up those markets (compared to reality).
If Pawn Shop Fed wanted to do the opposite, they would be doing a "reverse repurchase agreeement." This means Pawn Shop Alpha comes back for their goods and they give up cash (liquidity) and get their asset (coin) back - minus pawn fees. At this point, instead of rolling the transaction at previous terms, Pawn Shop Fed is jacking up their pawn fees, demanding a little more money.
The market naturally expects some pawn shops to refuse the new transactions, due to higher fees. This means, on total, all pawn shops have less and less cash, more and more of their stuff back. The less cash sloshing around, the higher rates go.
What ZH is reporting is that everyone just agreed to higher fees and nothing changed.
I might have some of this wrong, but this is as best as I can understand it and not be totally confused.
Regards,
Cooter
The Fed increased the rate they pay banks on reserves to 0.5% from 0.25%. So no bank would lend reserves to another bank (the discount rate) at a lower rate since the Fed has no counterparty risk. Thus the new discount rate is 0.5%.
But non-banks can't take part in the above scheme, so the Fed also is willing to accept money from non-banks, like money market funds, in return for Treasuries (reverse repo), at 0.25%. So that sets a floor on repo rates of at least 0.25%, for the same reason as above (no counterparty risk). Actually, the new repo rate floor is between 0.25% and 0.5%, for some reason I don't completely understand.
it floats within that range during the day but there is a floor put on it by the fed and the market provides the ceiling, .5%, the next floor for the fed.
SoCal called it out. All the guys talking about 'draining liquidity' have been duped just like traders/algos on Wall Street.
Reason being, because that's what the Fed had always done in the past.
When people figure out the opposite is happening - money supply increases to pay interest on bank reserves, not decreases - there will come an epic mood swing.
I think that helps to make it clear. Unfortunately, me thinks the banks have been behaving more like "Sentimental Value Pawn Shops":
http://www.nbc.com/saturday-night-live/video/sentimental-value-pawn-shop...
C'mon guys, we know a lot about deep water corals--oh, sorry.
Banks are required to keep a specific % of "cash" on hand VS how many dollars of deposits they hold. Cash can be actual cash but US treasury securities also count as cash.
When one bank is short of cash (or treasury securities) and another has excess - the bank with extra cash(T securities) will loan it to the cash poor bank over night -
It is just an accounting entry between the banks - but at the close of business the bank that was short of cash can show they borrowed the cash from the other bank - and both banks then meet the mandated standard.
When the fed floods the system with liquidity - few banks need to borrow - so since you have many more banks with excess cash VS banks that are short of cash - the interest rate charged for these over night loans will be low - it is simple supply and demand - if every bank has excess cash no one needs to borrow - the rate will be zero.
If the fed wants to increase interest rates - they will drain some of the excess liquidity out of the system - this causes more banks to need to borrow / reduces the number of banks with excess cash on hand - and as a result changes the supply / demand balance.
If more banks need to borrow to meet the cash requirement mandate it will raise interest rates.
*** Grossly over simplified but in general close enough to real to help understand the clusterfuck fubar mess of our system***
I'm not an expert either. Couldn't liquidity reduction be both induced and deduced? In other words, in the case of the former, the Fed doesn't dictate/impose a rate of rent but rather achieves its target by not replacing destructed currency (ie not rolling over some quantity of loans) leading to a decreasing money supply over time and thus leading to a natural rate increase OR (2) in the latter case, the Fed raises its target rate (by fiat / dictate / imposition), and this leads to less demand for debt in comparison to the previous rate (because debt-servicing just became more expensive) and thus to an eventual destruction of currency (that would otherwise not been destroyed / possibly even created under previous conditions) commensurate with the dictated raise in rates / drop in debt demand?
Seems to me this article suggests that the Fed should be decreasing the rate of money supply / debt-creation to achieve a target instead of dictating a target rate into existence in anticipation of a decrease in the rate of money supply / debt creation.
Or am I totally off my rocker?
It DOES NOT work that way, dip shit. You people need to STFU unless you really know what you are talking about.
The fed pays interest on excess reserves. Therefore, no other bank would ever loan money out at lower than the fed funds rate, because they could always get more by lending to the fed.
See? It's not so fucking hard that you fuck tards need to be making shit up.
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It's all fiat! This is news? What is a central bank but in charge by decree?
Nothing is real. And nothing to get hung about.
Just my luck I'm allergic to strawberries.
Spoilsport!
Oh...