Caution! The Fed’s Pop-Up Repo Windows Reflect Very Tiny Brains At Work

It doesn’t get any stupider than this. Just as fast as the Fed pumps up the size of its freshly minted repo facilities, demand for speculative borrowing leaps another leg higher.

After the Fed upped the overnight facility to $100 billion yesterday when it received $92 billion of bids under the original $75 billion overnight facility and announced three 14-day term facilities of $30 billion/$60 billion/$60 billion, the Wall Street gamblers have apparently said we’ll see your $250 billion and raise, again.

Thus, at this morning’s $60 billion term repo offer, the Fed received $72.5 billion of bids. And that wasn’t reflective of a mere overnight pinch: This was 14-day money!

Needless to say, the talking heads are gumming up a storm about why this is suddenly happening—quarter-end and all.

But there’s no mystery whatsoever. Two numbers from this morning’s Fed announcement tells you everything you need to know. We are referring to 1.86% and 1.89%, which were the “stop-out” yields on the $35.75 billion of bids for UST-backed loans and $24.25 billion for MBS-collateralized loans, respectively.

That is to say, the Fed has commanded that interest rates on all forms of money market loans including secured repo shall stay strictly within its current 1.75%-2.00% range. And that’s as in come hell, high water or, heavens forfend, the law of supply and demand itself.

There are truly very tiny brains at work in the Eccles Building. If this is just a quarter-end matter per the vast majority of Wall Street commentary, so what, then, if repo rates temporarily spill over the top of the Fed’s absurdly low Fed funds range?

Is the “greatest economy ever” actually so fragile that Wall Street dealers and hedge funds can’t afford to pay 5% or even 10% for a couple of days or weeks on their massive, money-making balance sheets where their carry cost is still negative after inflation? And has been for an entire decade!

And if the pressures roiling the money markets are of a more permanent nature—so what, again!

Always and everywhere, the ultimate cure for excess credit demand is higher rates, not more fiat money supply. And history shows that purging and clearing speculative markets does not kill capitalism; it rejuvenates it.

So this bears repeating: These $250 billion of instantly stood up repo lines have absolutely nothing to do with the main street economy or the Fed’s so-called dual mandate.

That’s because the 1.85%/1.89% yields accepted by the Fed this morning to fund Wall Street balance sheets are in a totally different universe than main street. Currently auto loans are 4-7%, personal loans range up to 17% and, according to Wallet Hub, rates on credit cards currently stand at 14% to 22% depending upon on credit scores

No, these “pop-up” repo windows have been hurriedly erected at the behest of the Wall Street whiners, who think the Fed owes them access to virtually unlimited ultra-cheap funding for their carry trade speculations.

Nor can you exaggerate the level of entitlement and greed involved. Way back in what is now ancient history—April 2008— the Fed lowered the funds rate to 2.0% in a desperate efforts to bolster a main street economy which was already in recession, even though the 12 FOMC geniuses managing the economy had no clue at the time.

As we pointed out a few days ago, the 12-month inflation rate was then 2.95%. So the cost of carry trade funding on Wall Street was a full point below the inflation rate and the gap only got wider from there.

By January 2012, for instance, the Fed funds rate was still down on the floorboard at a mere 10 basis points, while the trailing 12-month inflation rate posted at 2.60%, meaning that the real (inflation-adjusted) cost of money was -2.50%.

And, yes, that is a negative sign in front of the after-inflation cost of goods sold (COGS) for carry traders (i.e. their COGS is the short-term cost of the borrowed money with which they purchase their earning assets).

So the Wall Street traders literally thought they had died and gone to heaven. Indeed, only in December 2018 did the Fed get the effective funds rate a hair above the inflation rate.

That tiny rebirth of sanity, of course, was instantly stillborn when Pusillanimous Powell pivoted within days owing to the loud barking from the Oval Office and the plunging stock averages of Christmas Eve massacre.

So here we are 137 months from the original April 2008 break out of negative cost money and we are back under water with the Fed’s money market target rate of 1.85% well below the 2.19% trailing rate of inflation.

The latter inflation figure is from our preferred very stable and reasonably accurate 16% trimmed mean CPI. But if you don’t like that one, take this morning’s freshly revised Q2 data for the PCE deflator and the PCE deflator less food and energy, which the Fed heads like better because they generally measure inflation at somewhat lower rates.

But not now. The annualized rate of the PCE deflator for Q2 2019 was 2.36%, and when you lop off food and energy it was 1.90%.

Either way you cut it, the Fed’s mid-point funds target is below inflation. Yet, apparently, and so that no one is confused, it swooped in today with the aforementioned $60 billion of 14-day repo at 1.86%/1.89%. That is, clearing any and all money market decks at yields which are still negative in inflation-adjusted terms.

The way to view this is that the area in the chart below between the purple line (inflation) and the dark green line (Fed funds effective rate) is one great bubble bath of free lunch profits for the Wall Street dealers and gamblers.

So the question recurs: Why do the very tiny brain denizens of the Eccles Building insist on pleasuring Wall Street speculators in the prodigious profits pool depicted below?

Alas, it’s because these arrogant apparatchiks presume that they can defeat the law of supply and demand and that left to its own devices, capitalism has a death wish.

That is, free markets always get the interest rate wrong and it’s almost always way too high, thereby discouraging an invisible economic ether called aggregate demand.

By contrast, the 12 very stable geniuses who sit on the FOMC are purportedly endowed with the extraordinary wisdom needed to get it right. They enable the benighted souls of main street—workers, management, entrepreneurs and investors alike—to be guided to ever greater prosperity by the visible hand of central banking experts rather than stumble about chasing the unseen hand of mere commercial enterprise.

Of course, the fly in the ointment ain’t that hard to see if you are not drinking the Cool Aid of monetary central planning.



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