This is still hands-down the most valuable place for me to learn about markets and finance. I can't thank you enough! The visual representations here were perfect, well done!
My only question is, when RRP rates start going down again along with fed funds rates, this "absorbed" liquidity will make it to the markets again pushing prices up again, and pushing inflation up again?
Because if a recession hits, supply side will be weaker, and if you inject thus liquidity again, prices would soar. What am I missing?
Thank you for taking the time to write this out; your elegant analogy answers a host of questions that I’ve had for months about the role of the RRP. One question which remains for me: how is one to interpret the significance of the continual increase in funds parked in the RRP?
Wow, you knocked it outta the park with this one! That simple illustration you used makes so much bloody sense. I'm sitting here with my coffee staring out the window and thinking it all over. Ty
Another cool analogy! (The furnace one was absolutely brilliant BTW, it's stuck in my head.)
You deserve credit for this ON-RRP thing, you are the first one I saw spotlighting it as a factor for asset price devaluation. After you I found @maxjanderson on Twitter running a very compelling graph of Fed Balance Sheet ex-ON-RRP vs SPX, you should check it out.
At first I was skeptical, I didn't see a reason why ON-RRP would be any different than Bank Reserves at the Fed, it was just supposed to be a reserve account substitute for non-banks. The same way as banks put money with the Fed in their reserve accounts, MMFs parks them in the ON-RRP. Why would one have more impact on asset prices than the other?
What seems to be happening is that Reserves are a "higher octane" form of liquidity than ON-RRP. For a fixed size of the Fed Balance Sheet, any transfer of liabilities from Reserves to ON-RRP leads to muting of economic and financial transaction activity. It all makes sense when you see things from the POV of the actual economic actors, who are the liabilities counterparties to the Banks' and MMFs' assets (Reserves and ON-RRP, respectively). Bank deposits yield ~0.2% while MMFs are around 2.5%.
So what is happening is people (and other economic entities) are transferring money from Banks to MMFs, and keep them there. These MMF deposits are simply sleepier, lower-velocity money, they are less likely to chase stocks or cryptos than bank deposits.
It's certainly an interesting observation and gives the Fed another lever to control economic activity and asset valuations, by simply changing the delta between the interest on Reserves and ON-RRP. If they want to stimulate they can lower the ON-RRP rate relative to Reserve Interest (the latter I think has to equal FFR), and vice versa.
A lot of the more astute bloggers have said this: "The rate hikes will continue until something breaks" not until inflation goes down. That breakage will probably be a currency crisis like in the UK or Japan but much worse.
Thank you LBS, your observation about liquidity explains in part why the Vix has been sloping upward since de third quarter of 2021. It appears market participants recognize risk is increasing incrementally as the FED proceeds withdrawing liquidity. In your opinion, which option timing would make sense at this moment. A call on the Vix expiring this November or somewhat longer expiring January 2023. Please consider relating this article about liquidity to your 2021 article about volatility.
Thanks for your kind reply. Exactly, I remember the 5 legged race description and per your observation, VVIX started cooperating.
Best
Chris
Vivid, crystal-clear analogy!
This is still hands-down the most valuable place for me to learn about markets and finance. I can't thank you enough! The visual representations here were perfect, well done!
I can't believe this is free content.
Outstanding.
Thank you so so so much.
My only question is, when RRP rates start going down again along with fed funds rates, this "absorbed" liquidity will make it to the markets again pushing prices up again, and pushing inflation up again?
Because if a recession hits, supply side will be weaker, and if you inject thus liquidity again, prices would soar. What am I missing?
Thank you for taking the time to write this out; your elegant analogy answers a host of questions that I’ve had for months about the role of the RRP. One question which remains for me: how is one to interpret the significance of the continual increase in funds parked in the RRP?
Hindsight produces elaborate and beautiful narratives.
Extremely well done analogy. Congratulations. You're a really Talented writer.
Wow, you knocked it outta the park with this one! That simple illustration you used makes so much bloody sense. I'm sitting here with my coffee staring out the window and thinking it all over. Ty
Another cool analogy! (The furnace one was absolutely brilliant BTW, it's stuck in my head.)
You deserve credit for this ON-RRP thing, you are the first one I saw spotlighting it as a factor for asset price devaluation. After you I found @maxjanderson on Twitter running a very compelling graph of Fed Balance Sheet ex-ON-RRP vs SPX, you should check it out.
At first I was skeptical, I didn't see a reason why ON-RRP would be any different than Bank Reserves at the Fed, it was just supposed to be a reserve account substitute for non-banks. The same way as banks put money with the Fed in their reserve accounts, MMFs parks them in the ON-RRP. Why would one have more impact on asset prices than the other?
What seems to be happening is that Reserves are a "higher octane" form of liquidity than ON-RRP. For a fixed size of the Fed Balance Sheet, any transfer of liabilities from Reserves to ON-RRP leads to muting of economic and financial transaction activity. It all makes sense when you see things from the POV of the actual economic actors, who are the liabilities counterparties to the Banks' and MMFs' assets (Reserves and ON-RRP, respectively). Bank deposits yield ~0.2% while MMFs are around 2.5%.
So what is happening is people (and other economic entities) are transferring money from Banks to MMFs, and keep them there. These MMF deposits are simply sleepier, lower-velocity money, they are less likely to chase stocks or cryptos than bank deposits.
It's certainly an interesting observation and gives the Fed another lever to control economic activity and asset valuations, by simply changing the delta between the interest on Reserves and ON-RRP. If they want to stimulate they can lower the ON-RRP rate relative to Reserve Interest (the latter I think has to equal FFR), and vice versa.
Nice article and absolutely brilliant graphic. It does a fabulous job conveying the concepts.
A lot of the more astute bloggers have said this: "The rate hikes will continue until something breaks" not until inflation goes down. That breakage will probably be a currency crisis like in the UK or Japan but much worse.
Curious, why is the Fed's preferred tightening mechanism RRP rather than QT?
Thank you LBS, your observation about liquidity explains in part why the Vix has been sloping upward since de third quarter of 2021. It appears market participants recognize risk is increasing incrementally as the FED proceeds withdrawing liquidity. In your opinion, which option timing would make sense at this moment. A call on the Vix expiring this November or somewhat longer expiring January 2023. Please consider relating this article about liquidity to your 2021 article about volatility.
Thanks
Chris