My understanding of all of this is so many levels below you. I am an engineer by trade who graduated in 2010. The job market was non existent. As such, I have always been interested in the GFC, what caused it and how we “got out of it”. I saw your posts after the Michael burry retweet and haven’t stopped following. I have more or less come to the conclusion that we did not recover, we simply kicked the can down the road and are being led through a jungle as the fed uses a dull knife and a broken compass to forge a new path through thick foliage.
Your posts really are much appreciated, but also terrifying.
Jun 17, 2022·edited Jun 17, 2022Liked by The Last Bear Standing
"With liquidity policy, the Fed grabs an oboe and plays it with a leaf blower."
Great article, very informative. Well it was after I stopped to wipe the tears from my eyes after laughing so hard at this line.
Right now we're all at the Indy 500 and watching the cars races around, but it's just a matter of time until there's a crash. The only question is where will it happen on the track and what will be the cause.
Fabulous write-up. I started in biz trading FF in 1981 ( @jimdelisle) and thought I knew a lot, but your piece has prudently reminded me of how much I need to learn…and how relatively simple much of this learning can be with the right teacher framing the questions the right way.
Since 3Q21, it seemed apparent that the all in bet of Team Transitory was really risky with so many reserves already in the system and so many huge moving parts. I have been wondering and asking, as the wrongness of their bet became apparent in 1Q22, why they didn’t do an early end to the QE? It seems by your #s and logic, that an “aware” Fed would have realized it was already tightening aggressively behind the scene and have seen no purpose in such a public step.
Is that your belief (since I would love to retire that question without the “Jay Pow hadn’t been voted in again yet” conspiracy whiff)? And if that is so, does it not somewhat refute your assertion that the Fed really doesn’t understand these flows adequately to use them, let alone minimize the damage their misuse causes?
Interesting article, but with some misconceptions.
There is not much difference between different pools of liquidity. RRPs are just reserve accounts for non-banks, they serve the exacts same function and pay the same interest.
Prior to the GFC pretty much all of the Fed liabilities (="liquidity") were cash banknotes, but in the last 10-15 years depositary reserves have ballooned as a major fraction of liquidity/Fed liabilities.
QE policy liquifies higher interest-bearing assets into a liquid pool with interest that is about equal to FFR (but not lower). And with RRP they brought-in non-banks into the same pool. That may seem different than traditional liquidity (banknotes), which is generally thought to have a negative yield of ~ 0.5%, the cost of shipping, handling and storage of banknotes. However that's a misconception: prior to QE cash reserves were still positively yielding, because banks were lending them to each other and the Fed was successfully manipulating that rate on the open market (that's what target FFR actually is).
QE and explosion of liquidity made it hard for the Fed to control the interest on liquidity/reserves only through FOMC operations on the open market, so they decided to pay the FFR directly, to be able to transmit the monetary rate policy.
Some interesting things from your article:
1. one-month UST yield slightly lower than reserves/RRPs. That is indeed strange.
Entities without access to the reserve/RRP window (individuals, corporates, hedge funds...?) holding 1mo USTs directly vs deposits at bank/MMFs is the likely explanation.
2. The liquidity flow between banks and RRP users (MMFs) in the past few months. Likely explanation is that tightening financial conditions reduced CP and corp note issuance, pushing more MMF deposit money into RRP, while lines of credit at banks got drawn out, reducing bank reserves.
However, I don't understand why you think this has some profound unintended economic or market effect? It is just liquidity moving from one pool to another...
One stupid question: as MMF contains the money from investors which is now around 2 T USD, what could be the reason that those investors are not deploying those capital into the equity or bond market... the goal of MMF to provide a liquid and low risk but low return fund for investors to park their money but why are those investor not deploying those capital as bonds yield is spiking...... As RRR is increasing does this also mean that the money supply in the capital market is increasing?
I don’t want to sound like a moron, but I’m ok with that on these subjects. Any recommendations on where to start on my journey in learning more about the market and the ins and outs of investing, etc. I know it’s a huge subject and I only have experience in buying and trading some stocks and rudimentary knowledge on what makes a good company from my business degree.
Great article, if only I had come across it earlier! Thank you so much for taking to the time to explain liquidity in such details.... an article on bank reserves would be interesting
What I want to know and is a very significant risk coming soon is when the interest on excess reserves and the RRP EXCEEDS the interest earned on the treasury portfolio and MBS portfolio. My back of the envelope calculation using the first Q income statement from the Federal Reserve is a 3.15% rate on excess reserves and RRP is the cashflow neutral point assuming the amount of federal reserve notes (AKA Dollar Bills), which a zero cost liability for the Federal Reserve stays constant. I view QE as effectively an interest rate swap by a central bank, whereby they buy for example a 10 yr bond and issue an overnight reserve that they pay the overnight rate on. What happens when a central bank runs cashflow negative because the coupon interest isn't great enough to pay the increasing overnight rate on excess reserves and RRP? Answer: The treasury bails them out or the Central Bank puts a deferred IOU on the balance sheet and the treasury won't see a reimbursement from the Central Bank until that IOU goes away. Think about the assumption that the CBO had for $30B per QUARTER of Federal Reserve reimbursement to the Treasury? That will be gone for quite awhile and will increase the deficit along with the increased cost of Treasury debt rolling over. Now for the punchline: If you think it's bad with the Federal Reserve's balance sheet yielding approx. 2% on its portfolio on the asset side, think about the BOJ and their monster balance sheet of 0% - .25% yielding debt financed by overnight yen reserves. Think they can raise rates or give up on that YCC? And so many folks wonder why the yen is in freefall. That is a financial accident waiting for the world to witness and experience. Very scary stuff in Tokyo.
You have a really cool way of explaining stuff, that even a noob like me can understand. I would pay to read more content like this. Keep up the good work!
Thank you TLBS for taking the time to write this stuff. I definitely have to read this again a few more times slowly. I enjoy the comments section as I (like a few others) attempt to understand this environment better.
Do you think it makes sense to use an increasing monetary base as entry signal for stocks/bonds? Staying out market as long as the monetary base is shrinking ?
My understanding of all of this is so many levels below you. I am an engineer by trade who graduated in 2010. The job market was non existent. As such, I have always been interested in the GFC, what caused it and how we “got out of it”. I saw your posts after the Michael burry retweet and haven’t stopped following. I have more or less come to the conclusion that we did not recover, we simply kicked the can down the road and are being led through a jungle as the fed uses a dull knife and a broken compass to forge a new path through thick foliage.
Your posts really are much appreciated, but also terrifying.
Thanks again TLBS and keep it up
"With liquidity policy, the Fed grabs an oboe and plays it with a leaf blower."
Great article, very informative. Well it was after I stopped to wipe the tears from my eyes after laughing so hard at this line.
Right now we're all at the Indy 500 and watching the cars races around, but it's just a matter of time until there's a crash. The only question is where will it happen on the track and what will be the cause.
Fabulous write-up. I started in biz trading FF in 1981 ( @jimdelisle) and thought I knew a lot, but your piece has prudently reminded me of how much I need to learn…and how relatively simple much of this learning can be with the right teacher framing the questions the right way.
Since 3Q21, it seemed apparent that the all in bet of Team Transitory was really risky with so many reserves already in the system and so many huge moving parts. I have been wondering and asking, as the wrongness of their bet became apparent in 1Q22, why they didn’t do an early end to the QE? It seems by your #s and logic, that an “aware” Fed would have realized it was already tightening aggressively behind the scene and have seen no purpose in such a public step.
Is that your belief (since I would love to retire that question without the “Jay Pow hadn’t been voted in again yet” conspiracy whiff)? And if that is so, does it not somewhat refute your assertion that the Fed really doesn’t understand these flows adequately to use them, let alone minimize the damage their misuse causes?
Don't you think Fed will reduce interest on RRP soon? This may help money to leave RRP to other investments.
Interesting article, but with some misconceptions.
There is not much difference between different pools of liquidity. RRPs are just reserve accounts for non-banks, they serve the exacts same function and pay the same interest.
Prior to the GFC pretty much all of the Fed liabilities (="liquidity") were cash banknotes, but in the last 10-15 years depositary reserves have ballooned as a major fraction of liquidity/Fed liabilities.
QE policy liquifies higher interest-bearing assets into a liquid pool with interest that is about equal to FFR (but not lower). And with RRP they brought-in non-banks into the same pool. That may seem different than traditional liquidity (banknotes), which is generally thought to have a negative yield of ~ 0.5%, the cost of shipping, handling and storage of banknotes. However that's a misconception: prior to QE cash reserves were still positively yielding, because banks were lending them to each other and the Fed was successfully manipulating that rate on the open market (that's what target FFR actually is).
QE and explosion of liquidity made it hard for the Fed to control the interest on liquidity/reserves only through FOMC operations on the open market, so they decided to pay the FFR directly, to be able to transmit the monetary rate policy.
Some interesting things from your article:
1. one-month UST yield slightly lower than reserves/RRPs. That is indeed strange.
https://fred.stlouisfed.org/graph/fredgraph.png?g=QJhb
Entities without access to the reserve/RRP window (individuals, corporates, hedge funds...?) holding 1mo USTs directly vs deposits at bank/MMFs is the likely explanation.
2. The liquidity flow between banks and RRP users (MMFs) in the past few months. Likely explanation is that tightening financial conditions reduced CP and corp note issuance, pushing more MMF deposit money into RRP, while lines of credit at banks got drawn out, reducing bank reserves.
However, I don't understand why you think this has some profound unintended economic or market effect? It is just liquidity moving from one pool to another...
One stupid question: as MMF contains the money from investors which is now around 2 T USD, what could be the reason that those investors are not deploying those capital into the equity or bond market... the goal of MMF to provide a liquid and low risk but low return fund for investors to park their money but why are those investor not deploying those capital as bonds yield is spiking...... As RRR is increasing does this also mean that the money supply in the capital market is increasing?
I don’t want to sound like a moron, but I’m ok with that on these subjects. Any recommendations on where to start on my journey in learning more about the market and the ins and outs of investing, etc. I know it’s a huge subject and I only have experience in buying and trading some stocks and rudimentary knowledge on what makes a good company from my business degree.
Given the debt ceiling and need to fund and refill the TGA, which parts of the the financial system do you think provide the funding?
Great article, if only I had come across it earlier! Thank you so much for taking to the time to explain liquidity in such details.... an article on bank reserves would be interesting
I want to begin with a huge thank you for the info above and the weekly posts.
I have a couple of questions about the post:
1) where can I see the updated FED's balance sheet by the categories above?
2) where can I see the spread between the 1-month UST to the RRP?
Thank you again for everything
Question that I have been pondering is: How does this impact other currencies (Rand, Lira, Rupee, etc) where central banks hold $'s as reserve?
What I want to know and is a very significant risk coming soon is when the interest on excess reserves and the RRP EXCEEDS the interest earned on the treasury portfolio and MBS portfolio. My back of the envelope calculation using the first Q income statement from the Federal Reserve is a 3.15% rate on excess reserves and RRP is the cashflow neutral point assuming the amount of federal reserve notes (AKA Dollar Bills), which a zero cost liability for the Federal Reserve stays constant. I view QE as effectively an interest rate swap by a central bank, whereby they buy for example a 10 yr bond and issue an overnight reserve that they pay the overnight rate on. What happens when a central bank runs cashflow negative because the coupon interest isn't great enough to pay the increasing overnight rate on excess reserves and RRP? Answer: The treasury bails them out or the Central Bank puts a deferred IOU on the balance sheet and the treasury won't see a reimbursement from the Central Bank until that IOU goes away. Think about the assumption that the CBO had for $30B per QUARTER of Federal Reserve reimbursement to the Treasury? That will be gone for quite awhile and will increase the deficit along with the increased cost of Treasury debt rolling over. Now for the punchline: If you think it's bad with the Federal Reserve's balance sheet yielding approx. 2% on its portfolio on the asset side, think about the BOJ and their monster balance sheet of 0% - .25% yielding debt financed by overnight yen reserves. Think they can raise rates or give up on that YCC? And so many folks wonder why the yen is in freefall. That is a financial accident waiting for the world to witness and experience. Very scary stuff in Tokyo.
You have a really cool way of explaining stuff, that even a noob like me can understand. I would pay to read more content like this. Keep up the good work!
Thank you TLBS for taking the time to write this stuff. I definitely have to read this again a few more times slowly. I enjoy the comments section as I (like a few others) attempt to understand this environment better.
You should write for the Financial Times
Do you think it makes sense to use an increasing monetary base as entry signal for stocks/bonds? Staying out market as long as the monetary base is shrinking ?