Tag Archives: reverse repos

The Fed’s Rate Hike Was Largely Meaningless

Last week I suggested that if the Fed nudged up the Fed funds rate, it would likely trigger a pop in stocks and precious metals.    The reason is twofold.  First,  the markets would be relieved that lunacy surrounding the event was over – a “relief” rally, if you will.   Second, it’s obvious to everyone, the Fed inclusive, that the economy is tanking.  The stock/precious metals rally after the hike reflects the view that the next policy move by the Fed would be a reversal of today’s decision plus more money printing.

Paul Craig Roberts and I spent a few moments discussing the mechanics of Wednesday’s decision by the FOMC to raise rates.   The product of our discussion was his insightful commentary about the ramifications of the FOMC’s decision to hike:

What Does Today’s “Rate Hike” Mean?

Paul Craig Roberts – The link to his article here:  What Does Today’s “Rate Hike” Mean?

The Federal Reserve raised the interbank borrowing rate today by one quarter of one percent or 25 basis points. Readers are asking, “what does that mean?”

It means that the Fed has had time to figure out that the effect of the small “rate hike” would essentially be zero. In other words, the small increase in the target rate from a range of 0 to 0.25% to 0.25 to 0.50% is insufficient to set off problems in the interest-rate derivatives market or to send stock and bond prices into decline.

Prior to today’s Fed announcement, the interbank borrowing rate was averaging 0.13% over the period since the beginning of Quantitative Easing. In other words, there has not been enough demand from banks for the available liquidity to push the rate up to the 0.25% limit. Similarly, after today’s announced “rate hike,” the rate might settle at 0.25%, the max of the previous rate and the bottom range of the new rate.

However, the fact of the matter is that the available liquidity exceeded demand in the old rate range. The purpose of raising interest rates is to choke off credit demand, but there was no need to choke off credit demand when the demand for credit was only sufficient to keep the average rate in the midpoint of the old range. This “rate hike” is a fraud. It is only for the idiots in the financial media who have been going on about a rate hike forever and the need for the Fed to protect its credibility by raising interest rates.

Look at it this way. The banking system as a whole does not need to borrow as it is sitting on $2.42 trillion in excess reserves. The negative impact of the “rate hike” affects only smaller banks that are lending to businesses and consumers. If these banks find themselves fully loaned up and in need of overnight reserves to meet their reserve requirements, they will need to borrow from a bank with excess reserves. Thus, the rate hike has the effect of making smaller banks pay higher interest expense to the mega-banks favored by the Federal Reserve.

A different way of putting it is that the “rate hike” favors banks sitting on excess reserves over banks who are lending to businesses and consumers in their community.

In other words, the rate hike just facilitates more looting by the One Percent.

Impending Systemic Financial Insolvency

Suffice to say, whatever happened went far beyond what might be considered normal in terms of end of quarter window dressing. It’s impossible to tell, but it may have been related to Glencore and its counterparties (banks and other commodity traders?), or to increased mar-gin calls on derivative trades. The timing is also thought provoking given the recent announce-ments regarding write-offs and capital raisings from Deutsche Bank and Credit Suisse.  – Paul Mylchreest, “Do Central Banks Need A Plumber? Part 2”

I suggested in a blog post last week that the extraordinary “outlier” amount of reverse repo transactions conducted by the Fed with its system member banks beginning in mid-September went several standard deviations beyond the amounts used in quarterly bank “window dressing” maneuvers.

I received several emails, of course, suggesting I was wrong and that the all-time record amount of reverse repos was de rigueur.   Rather than write a blog post explaining why the “de rigueur” view is wrong, I was able to discuss the entire reverse repo process on Jay Taylor’s “Turning Hard Times Into Good Times” radio show:

The big spikes in reverse repos is designed to put collateral in the financial system which can be posted against losing derivatives trades.  As everyone knows, there has been highly problematic collateral shortage in the market for several years now as a result of Central Banks vacuuming up all the sovereign-issued paper for the purpose of being able to refer to Central Bank money printing as “QE.”

This shortage of collateral is a big problem when events occur that cause volatility in the OTC derivatives market.   While banks have access to the collateral of Central Bank balance sheets, non-Central Bank system financial entities do not (hedge funds, mutual funds, insurance companies, pension funds, etc).   But these are the entities that are often on the losing side of derivatives trades.  Thus they need collateral to post for margin.

Through the “magic” of hypothecation, banks can borrow collateral from the Central Banks (primarily the Fed) via the reverse repo operations and then hypothecate that collateral into the general financial system as needed.

UntitledTo be very clear about this, the timing of the Glencore stock plunge and the beginning of the spike up in reverse repos in mid-September is unequivocally not a product or natural random probabilities.   Especially when we find out a few weeks later that Deutsche Bank – a big lender to Glencore – seems to be “walking the financial plank.”

And, furthermore, Black Rock issues a public statement calling for markets to be “turned off” during times of high volatility.  Make no mistake, Black Rock is probably one of the most systemically dangerous financial institutions out there now.

And, perhaps the strongest signal in the market place that the Fed is terrified of an event that could crash the markets is the continuous and blatant intervention in the stock market.   The divergence between the valuation of U.S. stocks and underlying fundamental economic reality has never been greater in the history of the United States.