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‘A Whatever It Takes Signal’: Fed’s ‘Big Bazooka Of Liquidity’, Sets Up ‘QE-Lite’ In October

After a remarkable week, all eyes turn to October.

“What a week”, BofA’s Mark Cabana wrote on Friday evening, reflecting on a five-day stretch that afforded front-end rates strategists a rare moment in the limelight (Mark was on Bloomberg TV this week).

On Friday, the Fed sought to reassert control over funding markets, which went haywire to start the week as the collision of idiosyncratic factors (e.g., corporate tax date, coupon settlements and the previous week’s bond rout) and structural/legacy issues (e.g., ambiguity around what counts as “ample” when it comes to reserves, the ongoing deluge of supply from Treasury to fund the deficit and an onerous regulatory regime) triggered a pretty epic squeeze that grabbed all manner of headlines in the 48 hours prior to the September Fed decision.

Four straight days of overnight repos helped ease the squeeze (as it were), but between Thursday and Friday’s operations being oversubscribed, jitters about month- and quarter-end pressure and Jerome Powell’s seeming ambivalence in the post-FOMC press conference, market participants remained on edge, eventually prompting the Fed to release a schedule for liquidity injections which included a trio of term operations.

Read more: Fed Admits Return Of Funding Stress Likely, Announces More Repos, Term Ops

So, what now? Well, the widening in two-year swap spreads (which touched a record nadir on Thursday) after the Fed effectively said it would remain in the market through month- and quarter-end, suggests the quake is behind us, even if there will be aftershocks up to and until a more permanent solution is rolled out in the form of balance sheet expansion or a standing facility.

BofA’s Cabana called Friday’s Fed announcement “a big bazooka of liquidity that shifts them away from being reactive to funding market stresses and into a position to proactively manage reserves and money markets”.

“We interpret this as a ‘whatever it takes’ signal from the Fed and now assume the Open Market Desks will roll term repos in October and start permanent balance sheet growth as necessary”, he went on to write, adding that “the Fed responded to the suggestions that we and many other market participants offered yesterday and sent a signal that they do not want funding stresses to materially spike or worsen again”.

Of course, this means that come mid-October, the Fed will need to roll the three term operations coming next week, or else pre-announce outright asset purchases ahead of the FOMC meeting.

“The introduction of temporary OMOs to inject about $75bn of daily liquidity and three upcoming 14-day term repo offerings should alleviate stress over the quarter-end [but] there will be a sharp drop-off in liquidity around the middle of next month based on our reserve projections and stated expiry of the term offerings [which] suggests to us that the Fed will either have to roll over some term offerings on expiry, or potentially upsize its daily offering”, Goldman said on Friday night.

(Goldman)

The bank goes on to reiterate what is now obvious to everyone. “A more permanent solution is the resumption of asset purchases to offset reserve depletion [and] we expect the Fed will announce this at the October meeting”.

It goes without saying that if the Fed inexplicably decides to leave markets twisting in the wind midway through next month, it would not be a good look. “We believe the market would be very disappointed and repo vol would increase if term repos or outright purchases do not continue after mid-October”, BofA’s Cabana cautions.

As for how things will proceed in the near-term assuming the Fed doesn’t “plan” on screwing this up, BofA got a bit more granular with it on Friday.

“We expect an initial $250bn in purchases will be needed to return to an ‘abundant’ level plus a buffer, with $100bn to back away from the upward sloping portion of the demand curve, and a $150bn buffer to account for variation in other liabilities”, the bank said, reiterating a previous estimate before predicting that these purchases “will occur more rapidly to protect against a future funding squeeze, with a possible pace of $25bn per month… likely concentrated in bills, to further stem repo pressure”.

(BofA)

That latter bit about the bills is important. Thursday’s four- and eight-week sales didn’t go particularly well and as Bloomberg notes, “before quarter-end, the market will have to absorb more than $200 billion of bill and note auctions, starting with Monday’s three- and six-month debt”.


 

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8 comments on “‘A Whatever It Takes Signal’: Fed’s ‘Big Bazooka Of Liquidity’, Sets Up ‘QE-Lite’ In October

  1. All this is about context and individual experience levels of the reader. The academic Guru’s that dwell in these issues downplay or more typically do not venture opinions on these highly technical issues . That acts as a cloak and the rest of us Peons can thus run our mouths and be contramanded easily……At any rate , these things boil down to perceptions and the true outcome is held in the hands of “the future”.It is interesting to watch this type of dynamic and should be a learning experience for all. Cases like this that are fluid and void of absolutes are interesting ‘mental gymnastics’ especially on rainy Saturdays….

  2. $500bn QE-lite would roll back half the QT the Fed managed in 208-19, no? As Leon Cooperman said on CNBC earlier this week, too much paper out there and not enough collateral to back it. Can’t imagine that’s a recipe for long-term economic success.

  3. We are attempting to solve the wrong problem here with these band aids. The world is awash with liquidity and the banks are sitting on huge reserves. The problem exists because all that liquidity is being used to chase and fund every risky project imaginable in a world of negative (real and nominal) interest rates. Without true price discovery we are doomed to live in wonderland. I say come out of the rabbit hole, let markets set interest rates, stop protecting the fat cats with more QE, allow creative destruction of the zombie companies, subsidize the poor with MMT, stop the crazy wealth transfer from the middle class to the rich, ……bring on Elizabeth Warren… and I used to vote Republican..

  4. If TBL and UST sales are not going well at $1TR/yr deficit, why the confidence that they will go well at the $2-3-?TR/yr deficit levels implied by MMT?

  5. Vicissitude

    This matter is still very confusing, in mid-December, the following story was floated:

    “The Fed hopes the tweaks discourage banks from borrowing reserves at the lower fed funds rate and profiting on the higher IOER by leaving the reserves at the central bank. The goal is to encourage banks to lend rather than playing the rate arbitrage.

    If the fed funds rate continues to drift higher, forcing the Fed’s hand again in 2019, some analysts think the central bank could opt to halt its portfolio trimming earlier than expected. That could permanently leave the Fed with more assets and effectively a more accommodative stance. ”

    Then in May 2019, the Fed floats this:

    A New Frontier: Monetary Policy with Ample Reserves

    Arbitrage plays a key role in steering the federal funds toward the target. For example, if the FFR falls very far below the IOER rate, banks have an incentive to borrow in the federal funds market and to deposit those reserves at the Fed, earning a profit on the difference. This tends to pull the FFR in the direction of the IOER rate (Figure 6). As such, to conduct monetary policy, the Federal Reserve moves the FFR into the target range set by the FOMC primarily by adjusting the IOER rate.10

    Ok, so we have an arbitrage thing related to hoarding: The following (from 2017) helped explain this a little, so just sharing:

    “In fact, many foreign banks found it profitable to acquire and retain excess dollar reserves for the sake of earning the even more minuscule spread between the risk-free IOER rate and lower effective Fed Funds and private repo rates. We know that, because they’ve been arbitraging that difference for some time. Foreign central banks, in the meantime, have been parking money at the Fed through its reverse-repo facility, which allows them to arbitrage the spread between what the facility pays and rates on short-term T-bills. Before the Fed began paying banks to keep balances with it, these arbitrage opportunities simply didn’t exist.

    Why would any bank settle for a return on assets below its net interest margin? In fact, so long as bank loans are heterogeneous, and banks can set different prices for loans of differing quality, any bank that didn’t would fail to maximize its profits. Here it’s worth keeping in mind that, whereas the demand schedule for bank reserves (that is, the Fed’s demand for a bank’s callable loans to it) is, in effect, a horizontal line at whatever rate the Fed is paying, the demand schedule for loans slopes downward. Profit-maximizing banks will expand their loan portfolios to the point where the net marginal return on loans, which is necessarily below the net interest margin (which is a measure of the net return on banks’ overall loan portfolios) equals the IOER rate. Beyond that, reserves dominate loans. In equilibrium, in other words, parking another dollar at the Fed pays more than lending it does. Were IOER reduced to zero again, on the other hand, banks would once again find lending more profitable than reserve-hoarding, and they would continue to make loans until the net margin on them (the marginal net margin, that is!) itself approached zero.”

    https://www.alt-m.org/2017/06/01/ioer-and-banks-demand-for-reserves-yet-again/.

    But, what I really don’t understand, is why the Fed seemed to lose control of their market function, are they sending a signal that they will start to control this arbitrage in a new way, or is this a matter where they have really bad data and bad leadership … very confusing, so just trying to learn …

    ==> https://fred.stlouisfed.org/graph/?g=oWxM

  6. The banksters buy UST from Treasury and then sells them to the Fed. Go figure!

  7. Assume the Fed regains control of the EFF and this current drama subsides.

    It is still disturbing (to me) that although banks have around $1.3TR in excess reserves on deposit at the Fed, the Fed is still being forced to stand up a repo facility that was last regularly used when the excess reserves on deposit at the Fed were vastly smaller. And that the Fed is under pressure to resume buying Treasuries despite having made only modest progress cutting its balance sheet from the >$4TR reached through post-GFC QE.

    It’s almost like the current situation has an instability that requires Fed action to keep it stable.

    I wonder if the yield curve plays a part. After all, if a bank can get 1.800% IOER by keeping excess reserves on deposit at the Fed, why should it buy 10 yr UST that are yielding barely more and also are delivering significant price volatility? Or, heaven forbid, 2 yr UST that are yielding less?

    But the Treasury needs to sell well over $1TR of bills and bonds annually, and banks are (supposed to be) among the major reliable buyers.

    Okay, there’s times when other participants are big, big UST buyers for yield-chasing or flight-to-safety. But other times, investor demand will be lower. H has written about how FX hedging costs make USTs less attractive to foreign buyers. Active investors can unwind their speculative UST positions as fast as they built them.

    No matter what, Treasury has to sell those UST and TBL every month.

    Will we see UST auctions start to fail? Yields lurch up, hitting asset prices, sending Trump into orbit, from whence to nuke the Fed’s independence?

    Or will the Fed be forced to cut IOER and EFF, to fire its monetary stimulus bullets even though the official mandates of employment and inflation don’t require it?

    This would effectively result in both forms of stimulus – fiscal and monetary – cranked up to “10” – just to keep yields low, asset prices high, and Trump earthbound.

    Such a dynamic can’t go on indefinitely. Can it? We’ve been seeing UST bid-to-cover generally weaken over the past year, I think.

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