In the fall of 2019, the repo market had a severe liquidity crunch; the Fed had to intervene and inject funds into it, as unexpectedly, there were no buyers for the repo sellers, causing the overnight repo rate to skyrocket (ever so briefly) from 2.2 to 10%. The Fed’s support for the repo market ended up being extended all the way into the summer of 2020, raising all kinds of red flags, as this particular kind of Fed intervention had not been needed since 2009. When the dust finally settled, it was hard to discern, at first sight, how come in a booming economy, flush with liquidity, financial institutions were not willing to lend to one another.
The answer lies perhaps in a truth no one wants to hear; Quantitative Easing (QE) is an accommodative monetary policy, where the Fed in order to pump liquidity into the economy, purchases treasuries in the financial markets. In the months and weeks preceding the Sept. 2019 repo market “crash,” although in modest amounts, the Fed sold-back some of those treasuries, draining liquidity from the US financial system. It was only a limited attempt to begin a reversal of QE. But, if a marginal amount of Fed treasury sales caused a crash in the overnight repo market, REVERSING QE IS IN FACT AN IMPOSSIBILITY, HENCE THE FED IS EMBARKED IN A MONETARY TOOL THAT CANNOT BE REVERSED IN THE FORESEEABLE FUTURE.
Fast forward 10 months and our mad, mad world has become even madder. In a 180 degrees turn, we now have a reverse repo market bubble. At present financial institutions and market players are lining up every day -not to sell- but to buy treasury securities from the Fed through overnight reverse repo contracts. On June 14 and June 16, the Fed sold treasuries through overnight reverse repo contracts totaling $584 and $755 Billion -both historical highs- to financial institutions and market players. These enormous $ amounts are a clear sign that our financial institutions are drowning in liquidity, desperately needing to place it, even if it’s only overnight. More so, according to the Fed recently released minutes, “a modest amount of trading occurred at negative rates,” meaning that some US financial players selling treasuries through reverse repo contracts, were in fact paid interest overnight for doing so.
At present, every month, $120 Billion of the Department of Treasury (the right pocket) issued treasuries are bought by the Fed (the left pocket) through QE. While every day on the overnight reverse repo market, the Fed is selling treasuries back to the market for a few hours, reducing the very same liquidity being created through QE!
Because of the artificially low (even negative) rates, this massive wall of liquidity created by the Fed, is hardly finding its way into the economy, simply because it cannot be lent at a profit by the financial system. Quite the contrary, a meaningful portion of this monetary tsunami is going back to the fed every night through the reverse repo market, negating QE’s very own purpose.
THIS WAVE OF LIQUIDITY -RUNNING AMOCK- IS OF SUCH MAGNITUDE THAT IS BEGINNING TO CHOKE THE FINANCIAL SYSTEM. THE REVERSE REPO MARKET IS JUST ONE OF THE SYMPTOMS OF A MAD, MAD WORLD MADE OUT OF OF INORGANIC MONEY (NOT GENERATED BY THE ECONOMY) PRINTED FREELY BY THE FED OUT OF THIN AIR.