Editor's Note: The guest commentary below is from Christopher Whalen's The Institutional Risk Analyst.
This week in The Institutional Risk Analyst, contributor Ralph Delguidice ponders the aftermath of the retreat last week by the Federal Open Market Committee following the latest market volatility tantrum. Suffice to say that the FOMC has no stomach for deflation of any duration, thus we see the magical appearance of the "Powell Put" in financial commentaries.
But riddle us this: When is easing really tightening? First the Fed backed off further rate hikes, now we are talking about resuming asset purchases for the system open market account or SOMA. Sadly, the impact of renewed “quantitative easing” will be a further tightening of private credit as the FOMC does what is does best, namely caters to the debt issuance needs of the US Treasury.
None of these developments are a surprise to readers of The Institutional Risk Analyst and illustrate the growing conflict between prudential rules meant to ensure liquidity in banks and the voracious cash needs of Washington. Last week's events illustrate that the FOMC cannot pursue price stability in the face of $1 trillion annual deficits.
A Bigger Balance Sheet? (careful what you wish for)
By Ralph Delguidice
The credit-cartel-consensus has concluded that the Fed has made up its mind to end the balance sheet roll-off “early;” whatever that means.
Chairman Jerome Powell suggested a near term equilibrium where reserves are “plentiful,” and that may indeed mean soon; but on closer examination it may surprise many and turn out to imply TIGHTER credit in the hard money markets where real companies fund and leverage on a secured basis.
A larger balance sheet—with all of the associated moving parts like currency demand and the Treasury General Account (TGA)—will mean more reserves for banks to use to satisfy the Liquidity Coverage Ratio (LCR) and Resolution Liquidity Adequacy and Positioning (RLAP) requirements that already see Fed reserves as BY FAR the most efficient of all qualifying assets.
In fact, for global systemically important banks (G-SIBs), RLAP is calculated intra-day and that leaves ONLY Fed reserves as effective.
With more bank assets tied up in Fed reserves—and more “sponsored REPO” giving Money Market Funds and CCPs direct access to the Fed as a counter-party to REPO sellers-- the supply of credit that can flow into private REPO markets will fall all else equal.
This will be coming at the same time that VASTLY increased US Treasury (UST) issuance will need to be cleared into the private bond markets. The Treasury Borrowing Advisory Committee Members (TBAC) report last week was VERY clear that much more US savings were going to be needed go forward as foreign demand for UST could not be counted on. With rates where they are these UST positions will increasingly need to be financed—either by intermediary dealers or end users--, and this turns banks that were SELLERS of REPO into BUYERS of REPO.
Yesterday was month end, and we saw UST GC printing at 2.90%
Yes, it was one day. But the quarter end spikes are higher and last longer, and the Year End is flat out crazy. Remember that this is all the time when then SOMA balance sheet roll-off was intact (it still is, of course) and the Fed was encouraging dealer banks to lend back into the private money markets.
AKA: “normalization.”
Now stop the run-off music and tell the banks to hold more reserves at the Fed, what do we think happens? Policy honchos need to ponder the conflict of LCR/G-SIB rules with monetary policy. Isn’t that called “macropru”?
Bottom line here is that the global money markets are a complex cascade of arbitrage that recent history shows can-- and certainly will —amplify any changes to the Fed footprint in reserve demand in uncertain and sometimes counter-intuitive ways.
As BAML said in a recent piece on the possible need for a Fed Backstop the REPO market:
“has become increasingly fragile and sensitive to shifting behavior of key market participants, especially banks and dealers, the strategists wrote.”
Chris Whalen wrote recently in The IRA that the Fed wanted to “nationalize” the money markets once and for all as a way to ensure financial stability. This rings increasingly true as we get visibility into the eventual size, tenor and composition of the SOMA account, and buyers of financial stocks would do well to remember that structural changes to the money markets that involve a permanent Fed presence may change the REPO alchemy (Hey!! it’s a loan AND a sale!!) that they have taken for granted for all these many years.
Just Sayin',
EDITOR'S NOTE
Christopher Whalen is Chairman of Whalen Global Advisors LLC. He has worked in politics, at the Federal Reserve Bank of New York and as an investment banker for more than 30 years. He is the author of three books Inflated (2010), Financial Stability (2014) and Ford Men (2017).
In 2017, he resumed publication of The Institutional Risk Analyst and contributes to many other publications and media outlets. He recently launched the first volume of The IRA Bank Book, a review of the operating and credit performance of the US banking industry written for institutional investors.