Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.
Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense” – The Lehman Brothers Inside Story – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.
“The Fed Guy” https://fedguy.com/the-
QT – The Federal Reserve Promises $1T in 12 Months?
We have a Federal Reserve promising to take their overnight rate to 4.5% (in March, just six months ago – the lending rate was 0.25%) and reduce this balance sheet by $1 trillion over 12 months – we were born at night, just NOT last night. Why is this important? The speed – in the balance sheet reduction process has a colossal impact on liquidity inside the market – all with a significant impact on asset prices. In Q4 2018, when the Fed ramped up its balance sheet reduction fantasy – equities crashed. Never – ever forget, that the Fed and their Wall St. pawns were promising $2T of QT last cycle. That was BEFORE the beast inside the market – stopped them in their tracks near a $685B balance sheet reduction. After all the bogus promises – they actually restarted QE, rebuilding their balance sheet in Q3 2019.
The Fed Guy
The “Fed Guy” says Quantitative Tightening may be more difficult than the Fed hopes. What a revelation!!! Moses has come out of the desert. Why? Because along with its QT aspirations, the Fed would like total bank reserves to be about ~$2 trillion, about 8% of GDP. They have NO clue whether or not that’s the appropriate number – but they want us all to believe they have a clue. The Fed believes that is the requisite amount to keep the financial system running smoothly. In Q4 2018, they proved — beyond a shadow of a doubt — that they have ZERO clue whether or NOT that’s enough liquidity. Now, the Fed wants us all to believe they control liquidity with precision – hilarious!!! And YES, the largest central bank on the planet is reducing liquidity like a blind man reaching into darkness.
2022
Bitcoin: -55%
Nasdaq: -23%
Russell 2000: -15%
S&P: -14%
Dow: -11%
Gold: -5%
US Dollar: +14%
Oil: +18%
Uranium: +22%
Finger Sandwiches
Of course – the Fed does not control where that liquidity is drained from. If liquidity drains from banks’ reserves, it is possible reserves could go below the Fed’s pain threshold, in which case, QT would stop. Tim Duy is a nice guy, a real talent – but a constant Fed lap dog, God bless him. Of course, guys like Tim want to make sure they still get those finger sandwiches at the sucking-up cocktail parties complete with Fed Governors and ex-central bank farm hands. For more than a decade – we have seen this charade up close and personal in Manhattan. This is as critical as you will EVER see the “Fed Guy” – this fact, in itself means a lot. Likewise, if Treasury issuance was also to be funded mainly by cash investors, and not by hedge funds buying through leverage accessed from the Repo market — You know those “relative value” clowns that blew up the financial system heading into Covid with 8-1 leverage – see the penny – insert steamroller, insert face plant crowd — that would also drain cash from the banks, hurting reserves. It will take some time. Bank reserves now are at about $3 trillion. Indeed, the Fed may like to see excess reserves decline, reducing the amount it has to pay on reserves thereby.
The $300B Hole Treasury Must Fill
As macro maven – Ben Melkman points out – the higher the Fed pushes up Fed funds near 4% – the higher the probability they are going to be short $250B to $500B annually (interest on reserves owed to Jamie Dimon and the rest of the big banks). Complete with hat in hand looking up into the eyes of Senator Elizabeth Warren next summer at the Humphrey Hawkins sit down with Powell on Capitol Hill. You see – the side effects of the collapse of Lehman Brothers and the financial crisis are on stage here. Regulators forced US banks to “reserve up” and so – for the last 14 years – Wall St.’s financial epicenter stored an enormous amount of reserves – US Treasuries. Today, the Fed must pay these banks interest on reserves as promised. But as the central bank hikes rates – the unintended consequences are MOUNTING along with a political backlash bigger than a Trump appearance on “The View.”
Massive USD Credit Risk
With nearly $13T of dollar-denominated debts oozing through the smallest countries on earth – there are significant side effects as the Fed tries to conduct monetary policy. Emerging markets are blowing up as the Fed´s strong greenback exports inflation to our planet´s poorest countries. Inflation-driven, political instability is at multi-decade highs and U.S. dollar headwinds are picking up with intensity. People do NOT understand – it’s GAME OVER for the US dollar – the MOST crowded trade on earth. Over the next 24-48 months – the Fed´s ability to support asset prices is highly limited without significant USD decay (Modern Monetary Theory). It is a COLOSSAL maturity – cash flow mismatch – your U.S. front-end rates are extremely high (borrowing 350bps) – and the yield on the average weighted maturity on their bond portfolio is low (trillions paying 75bps or less). For the last 20 years – this WAS NOT the case. Foreigners own $20T MORE U.S. Treasuries than U.S. investors own foreign debts. Furthermore, there are those who think banks don’t need as many reserves as even $2 trillion.
“Across what Zoltan would call the ‘Outer Rim’ of USD funding. The banks are flush, and UST repo demand is low (thanks in part to the Fed itself) so the cash is deployed into more profitable funding silos like FXswaps and AAA ABS. Read the OFR report on bilateral repo, it’s 2Tn! The Fed will begin ‘selling UST at 100Bn, while Treasury increases issuance 100Bn. That will spike demand for UST funding, which can be met with RRP cash. But that balance sheet must be held PRIVATELY. MMFs (money market funds) cant buy coupons, only repo. A dealer must offer that repo.” via @Stimpyz1.
We think they do, but we recognize estimates as low as $900 billion. Nobody really has a clue, that is a fact. This lower theoretical level is based on the fact that banks can increase reserves at will when the financial system is operating normally. However, we note that reserves aren’t even needed at $900 billion when the financial system is operating normally. Reserves don’t exist for normal times. They exist for abnormal times. The Fed itself can directly increase reserves by buying T-bills, as they did in 2019. The Supplementary Leverage Ratio (SLR) creates regulatory expenses for banks holding reserves. Apparently, these are not so onerous as to stop banks from having more reserves than they need. Nonetheless, the SLR could be relaxed if reserves fell towards $2 trillion. Thus, there are methods the Fed could use if Reserve levels were to fall too much. And, of course, they may not fall all that much. Net net, we think the Fed would indeed like to see Excess Reserves decline moderately without threatening the current mandated reserve levels.
“I don’t doubt Ben’s math for a second. and I can’t wait for the Elizabeth Warran – Powell shakedown in July 2023 – I am sure he is right. But given the Fed owns $8.2 trillion of stuff that yields on balance on average something, that income is subtracted from the $208B the Fed would pay out if rates jacked to 4% (AND reserves did not decline AND RRP assets did not decline after a QT of any kind at all – unlikely). This means there is some other line item that Ben is looking at besides interest to be paid on Reserve Balances and RRP. It would be nice to get a back of the envelope from him on how 4% leads to $250B to $500B net expense. Clearly, I am missing something.” NY-based CIO in our live client chat.
Don’t miss our next trade idea. Get on the Bear Traps Report Today, click hereInstitutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.
Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense” – The Lehman Brothers Inside Story – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.
