The Fed has a money market crisis on its hands. It’s a “crisis” that everyone should have seen coming because the handwriting has been on the wall for months.
Yesterday, in an emergency Repurchase (Repo) Temporary Open Market Operation (TOMO), the Fed offered banks $75 billion in overnight loans. The central bank was responding to a crash in the money markets that saw open market repo rates surge to 10%.
You saw the news stories yesterday. The mainstream media and Wall Street talking heads acted as if this was a surprise, a shock. Meanwhile, I’ve been warning in Liquidity Trader for months that when the debt ceiling was lifted, the money markets would start to reflect the pressure soon after, and interest rates would rise.
I have also warned that it would require a response from the Fed.
After a month of increasing pressure following that lifting of the debt ceiling, that rise came with a bang yesterday. How “unfortunate” for the Fed that it came on the first day of a two day FOMC meeting. The pressure is on them to respond. But how?
Fed Money Market Crisis Was No Surprise
Last night I posted a regular monthly update on a select group of the Fed’s weekly banking indicators. These indicators paint a beautiful picture of what is going on in the banking system with just a few charts. They’ve been warning us for the past year that the primary driver of the stock and bond rallies has been margin and repo borrowing. The exponential rise in this type of credit was an accident waiting to happen. I have repeatedly warned that, “This will not end well.”
Yesterday’s money market dislocation was the beginning of the end. I wrote in that Liquidity Trader banking report last night:
We’ve begun to see problems in the money market as a result of the massive increase in repo borrowing to finance Treasury issuance and stock speculation. Overnight repo rates spiked to 10% today in the secondary market today. The extreme tightness suggested a lack of cash available to purchase the onslaught of Treasury borrowing totaling $228 billion over the past month.
As a result, the Fed was forced to offer $75 billion in overnight repos to finance the Treasury carry, in order to keeping the Fed Funds rate within the target range. The dealers took $53 billion of that repo money.
No doubt, this will need to be rolled over ad infinitum, and even increased, as Treasury supply keeps coming.
The Fed Just Confirmed this Money Market Crisis is Only Just Beginning
Today we got confirmation of that. The Fed announced another $75 billion overnight repo operation this morning. This time, the dealers took down every penny of it, and in fact, there were bids for $80 billion. This was only good enough to keep the Fed Funds rate at the top end of the target range.
I’m writing this before the FOMC statement, so I don’t yet know what they’ve decided. But I will say this. They are boxed in. In order to keep rates within the target range, the Fed will need to print like mad. Lowering the target range will only exacerbate that problem. They already have their hands full at the current 2-2.25 target range. Tuesday’s weighted average rate was above the range, and today’s was right at the top of the range.
With the US Treasury set to crush the market with supply as far as the eye can see, if the Fed wants to even keep rates at current levels, it will need to fund these Treasury offerings. That means that it must do either outright QE, direct purchases of Treasuries, or stealth QE in the form of these massive repo operations that will only grow over time. Instead of buying the paper outright, the Fed will just print the money out of thin air, and lend it to the Primary Dealers so that they can buy the paper.
The Fed Who Hesitates Is Lost
If the Fed even so much as hesitates, the bond and stock markets will crash at some point, probably sooner, rather than later.
I’ll report on this ongoing saga regularly over at Liquidity Trader with 6 or 7 monthly reports on the Fed balance sheet, key US banking system indicators and a few key foreign monetary and banking indicators; supply and demand conditions for the US Treasury market; and a regular look at real time Federal tax and spending data.
By closely following, charting, analyzing and reporting the stories these data sources are telling, I’ve been able to identify potential market problems months before the Wall Street crowd wakes up to them.
You Must Stay Informed
Typically, Wall Street doesn’t want you to pay attention to this stuff. The Street prefers that you remain ignorant. It’s just so much easier to manipulate an uninformed public. My job is to keep you always aware and prepared for the next big move. Because if you are paying attention to the right, unbiased data, there should be no surprises.
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