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The Perfect Storm – WSE Pro Fed Report Weekly Roundup

The markets face a crucial turning point in the actions of the Fed, Treasury, and FCBs over the next two weeks. The Treasury, which is broke, faces a huge rollover of intermediate and long term paper, plus it has to pay for the ecostimulus. At the same time that the market will face this enormous increase in the government’s short term borrowing, which should put upward pressure on money market rates, the Fed somehow has to defend a 2% funds rate. How will it do that, other than with massive injections of cash? Finally, the Fed has had record levels of help from FCBs over the past several months, and this week was no exception with FCBs adding record amounts of Treasuries to their holdings at the Fed. Can they keep up the pace? Click here to download complete report in pdf format (Professional Edition Subscribers). Try the Professional Edition risk free for thirty days. If, within that time, you don’t find the information useful, I will give you a full refund. It’s that simple. Click here for more information.

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6 Comments

  1. stevieo

    You mentioned http://www.ustreas.gov/press/releases/hp945.htm which mentions negative repo rates. Put together with paying interest on reserves, it make me wonder…

    Paying interest on reserves. Taxpayers (we) will pay interest on the portion of their (our) deposits banks don’t lend out to others. (we pay interest to the banks on our own money.)

    Negative repo rates. Taxpayers (we) will pay interest to lend money to banks when they use our public debt as collateral. (We pay them to borrow from us!?!)

    So I wonder what the plan might be… Can’t quite put it all together, though.

    Demand for treasuries is high as a safe haven and because they’re used as collateral for loans–repos.
    The cost of borrowing using treasury collateral is near 0.
    But noone wants to lend them out.
    Much of our treasury debt is held by FCBs that won’t lend them out.
    Many other participants are afraid to lend out their treasuries.
    The government needs to create a market for more treasuries to finance more debt.
    It also needs money from somewhere.

    The Fed takes treasuries out of private hands by offering a negative repo rate.
    This lowers the supply of treasuries in the market.
    It also increases the money supply.
    Treasury fills the supply gap by issuing more debt.
    This moves the new money from private hands into the Treasury account.

    At this point, the Treasury has the new money, and the Fed has the Treasuries on loan.
    Due to the negative repo rate, taxpayers are paying interest to the dealers for lending their treasuries to the Fed.

    The Fed can loan out those extra treasuries through its laundering facility.
    This fills the Fed’s balance sheet with laundry, but removes the treasuries it took in from repos.
    The treasuries exchanged for laundry will be put back after rates rise, at a tidy profit to the banks.
    Presumably, the profits from that help offset the losses when they finally take back the laundry.

    The banks can use these treasuries to borrow funds at low cost.
    Alternatively, the banks can lend these back to the Fed and collect interest on the negative repo.
    If not, they can swap them for more laundry.
    Finally, they can keep it as reserves and collect interest from taxpayers.

    So the Fed’s balance sheet shows an increase in total laundry.
    It also shows an increase in money supply.

    No matter how I try, I can’t get rid of that new money, yet I know the plan is to make it disappear.

  2. stevieo

    I suppose the destruction of loans is being replaced by government loans. Put another way, the deflation (destruction of money in the banking system through write offs) is replaced by new money created by the Fed. It’s done through this roundabout mechanism because it’s illegal for the Fed to directly monetize the treasuries.

    It’s fighting deflation with inflation. Same old, same old Fed policy. Debt destruction transfered to public debt, but in a way few will recognize as a straight bailout. I know they can manage money supply if (and only if) capital destruction occurs as fast as new money is created.

    Assuming this is how it’ll be managed, what are the consequences? I just don’t see the rest of world buying this.

  3. Lee Adler

    I regret that I don’t follow. What do you mean “it’s illegal for the Fed to directly monetize the treasuries.”

    That’s one of the Fed’s primary functions. Not only is it perfectly legal, it’s what they do when it’s needed. Are you referring to something else?

    Nor will the taxpayers be paying interest on the reserves. The Fed will pay interest out of its operating surpluses, or just print it.

    Could you post the link to a reference about negative repo rates? That seems absurd to me, so I need to see the context of what you are referring to. If anything, as the Treasury socks the market with supply, rates will rise.

    I think that you have overcomplicated the issues here. Or at least complicated them to the point that I can’t quite grasp what it is that you are saying.

  4. ter

    “negative repo rate trading practices” appear in the 16th paragraph of the Fed’s Report to the Secretary referenced in #1. Introducing this practice is said to have “some support” on the committee because it would facilitate sourcing securities etc. So, it may be absurd, but some on the FOMC believe in it– whatever it is.

  5. stevieo

    I thought the Fed was not allowed to buy treasuries directly from the Treasury. Only indirectly from the market.

    For the interest, it comes from the Fed’s operating income, but it means less profit, so it’s money they won’t return to the Treasury, so ultimately, we pay it.

  6. stevieo

    Oh! Now I see what you mean. They can just print it. Comes right back to my conclusion that I don’t see how they do this without “printing”.

    Wish these posts could be edited so I don’t nave to post twice… Or, heaven forfend… think before hitting submit.

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