Fed can't keep the rates low

[Cigarbutt]

Saying everyone’s wrong comes with the very real risk of being irrelevant.

A last irrelevant bit, for a while:

The best part (IMO), which lasts one or two seconds, of The Big Short is at 2:09 of this clip. That fleeting smile. It seems that being able to feel what Dr. Burry is feeling then may mean that there is some understanding and perhaps less of a disconnect than the main character displays overall with his environment.

The Big Short (2015) - Dr. Michael Burry Betting Against the Housing Market [HD 1080p] - YouTube

And he’s not always wrong. 

[stahleyp]

On 5/23/2021 at 11:36 AM, wabuffo said:

This is all interesting, but why should the average investor care about this?  I don’t see any relevancy for myself and probably the vast majority of investors.

I didn't mean to bore everyone with explanations of how the system actually works.   I'll stop posting about it.

wabuffo

No. Don't even think about it. It is incredibly nerdy, but that's good.

[Munger_Disciple]

wabuffo,

Your posts on the inner working of the Federal Reserve have been an excellent source of education for me. Please don't even think about thinking about not posting . 

MD

[JRM]

Could somebody explain to a 5 year old what is going on right now with the reverse repo purchases?

[wabuffo]

Could somebody explain to a 5 year old what is going on right now with the reverse repo purchases?

A reverse repo is a swap of assets between the Fed and the US banking sector.   The banks give the Fed a reserve asset (ie - Fed funds (ie, reserves) from their deposit accounts at the Federal Reserve) in exchange for a Treasury security from the Fed.  These are typically overnight (or over-the-weekend) durations - but since mid-March, they are constantly rolling over and growing so in effect its kinda perpetual for now.

The reason for this is because US Treasury spending and Fed open-market buying of Treasury securities due to the Federal government's pandemic response has flooded the banks with excess reserves.  Before the pandemic started, the US banking system had $1.7t in total reserves (9% of total banking sector assets).  Today, total reserves are a shade under $4t (or almost 18% of total banking sector assets) and continuing to grow.

Ok - so why now?  Why are the banks doing more and more reverse-repo after not doing much if at all before mid-March?  Here it gets a bit more technical and it involves something you haven't heard about lately - the Congressional limit on US Treasury securities outstanding - aka - the "debt ceiling".

The US debt ceiling was suspended on Aug 1st, 2019 for two years as part of the last set of budget negotiations.   The US Treasury thus had no upper limit for how much it could issue in net, new Treasury securities.  This came in handy during the pandemic as it ramped up its issuance and ran its Treasury general account (TGA) balance at the Fed to a high of $1.83 trillion during the summer of 2020 by issuing way more securities than it needed to fund pandemic spending.

 

But the debt ceiling toggles back on this Aug 1st. because the two year limit is ending.  In addition, the rules say that the US Treasury must have an account balance at the Fed = to what it was before the debt ceiling was suspended (basically to prevent the sort of thing that actually happened - i.e. running up the TGA balance).  The US Treasury's balance back then was $117.6b.  Its current balance is $832.9b.   So in theory, it must deficit spend $715b between now and then WITHOUT any net issues of US Treasury securities. (IOW, new issues cannot exceed maturity redemptions).

 

In reality, if it spends the same amount over this period (May 21 - July 31st) as last year = $638.9b - that won't be enough and it will have to net redeem a further $76.5b of US Treasury securities (ie maturities less new issuance).  But tax receipts are running higher this year than last year - so it may have to net redeem more than $76.5b because this year's deficit could be slightly smaller than last year for the same period.

 

But the Fed is still out there buying Treasury securities from the open market and removing them from the private sector (in exchange for bank reserves).  I reckon at its current pace the Fed will buy $177.9 b of Treasuries during this May 21 - July 31st period.

 

So to summarize - the US Treasury will deficit spend around $639b (probably less).  In the old days when the US Treasury used to run with a small TGA at the Fed - its net issuance equaled the deficit spending.  But not this summer.   Not only will the US Treasury not remove that $639b of new bank reserves by adding new Treasury securities -- between it and the Fed, they will WITHDRAW another combined $254b of US Treasuries from the private sector.

 

Unless the debt ceiling moratorium gets extended, that's a lot of cash and reserves sloshing in the system looking for yield.  And they are now starting to crowd at the Fed's reverse repo window.  If the Fed didn't do this, short-term rates could not be supported and we'd start to see negative rates at the short end.

 

Here's some data to illustrate what I'm talking about.

I've divided the pandemic and recovery into several periods.   When the pandemic hit the economy in March - June 2020, the US Treasury unleashed very heavy spending (Stimmie I).  It also more than covered its spending with huge Treasury security issuance in order to run up its Fed TGA.  But the Fed was also out there massively buying Treasuries.   The net result was that about 78% of the spending was covered by net supply of Treasuries (between the Fed and the US Treasury's buying and issuing).   But since the economy was ice cold, demand for US Treasury's after an initial panic was lower too.

But look at the period coming up now (May 21 - end of July 21).  A fast-recovering US economy needs US Treasuries, not just for more yield than cash, but as collateral for increased financing/lending.  But supply is actually going to shrink vs new reserve creation via deficit spending.  

Its no wonder everyone is piling up at the reverse-repo window since mid-March.  That demand is only going to continue to go higher every week.   I think the pressure on yields will also be felt at the long end of the yield curve.  Its no wonder that the yields rising were stopped in their tracks in mid-March (right at the time of that massive one-day deficit due to Stimmie III checks/deposits plus the US Treasury starting to ramp down its TGA).

Happy to answer any questions if I can.

wabuffo

Edited May 27, 2021 by wabuffo

[Spekulatius]

Seems like a game of musical chairs with not enough chairs. Fed buying treasuries (in exchange for reserves) then repo'ing reserves in exchange for treasuries. I guess it all makes sense, but does it accomplish anything? I doubt it.

 

I guess someone somewhere grabs a few pennies in front of some sort of steamroller.

[wabuffo]

Seems like a game of musical chairs with not enough chairs. Fed buying treasuries (in exchange for reserves) then repo'ing reserves in exchange for treasuries. I guess it all makes sense, but does it accomplish anything? I doubt it.

I think you are right Spek.  

The Fed used to run a corridor system to control short-term rates pre-GFC to control rates - buying/selling Fed funds (reserves) to keep rates in a tight range.   This was at a time when there were no excess reserves. 

The conceit of the Fed after it did QE was that it now could control both the price and quantity of the money supply - not just price.

But here we are - back where the Fed started.  It really can't control the supply of money - only the price.  It has to do reverse repo to keep its target rates from falling below the zero floor.   Its a fugly corridor system once again.

wabuffo

[rranjan]

1 hour ago, wabuffo said:

Could somebody explain to a 5 year old what is going on right now with the reverse repo purchases?

A reverse repo is a swap of assets between the Fed and the US banking sector.   The banks give the Fed a reserve asset (ie - Fed funds (ie, reserves) from their deposit accounts at the Federal Reserve) in exchange for a Treasury security from the Fed.  These are typically overnight (or over-the-weekend) durations - but since mid-March, they are constantly rolling over and growing so in effect its kinda perpetual for now.

The reason for this is because US Treasury spending and Fed open-market buying of Treasury securities due to the Federal government's pandemic response has flooded the banks with excess reserves.  Before the pandemic started, the US banking system had $1.7t in total reserves (9% of total banking sector assets).  Today, total reserves are a shade under $4t (or almost 18% of total banking sector assets) and continuing to grow.

Ok - so why now?  Why are the banks doing more and more reverse-repo after not doing much if at all before mid-March?  Here it gets a bit more technical and it involves something you haven't heard about lately - the Congressional limit on US Treasury securities outstanding - aka - the "debt ceiling".

The US debt ceiling was suspended on Aug 1st, 2019 for two years as part of the last set of budget negotiations.   The US Treasury thus had no upper limit for how much it could issue in net, new Treasury securities.  This came in handy during the pandemic as it ramped up its issuance and ran its Treasury general account (TGA) balance at the Fed to a high of $1.83 trillion during the summer of 2020 by issuing way more securities than it needed to fund pandemic spending.

 

But the debt ceiling toggles back on this Aug 1st. because the two year limit is ending.  In addition, the rules say that the US Treasury must have an account balance at the Fed = to what it was before the debt ceiling was suspended (basically to prevent the sort of thing that actually happened - i.e. running up the TGA balance).  The US Treasury's balance back then was $117.6b.  Its current balance is $832.9b.   So in theory, it must deficit spend $715b between now and then WITHOUT any net issues of US Treasury securities. (IOW, new issues cannot exceed maturity redemptions).

 

In reality, if it spends the same amount over this period (May 21 - July 31st) as last year = $638.9b - that won't be enough and it will have to net redeem a further $76.5b of US Treasury securities (ie maturities less new issuance).  But tax receipts are running higher this year than last year - so it may have to net redeem more than $76.5b because this year's deficit could be slightly smaller than last year for the same period.

 

But the Fed is still out there buying Treasury securities from the open market and removing them from the private sector (in exchange for bank reserves).  I reckon at its current pace the Fed will buy $177.9 b of Treasuries during this May 21 - July 31st period.

 

So to summarize - the US Treasury will deficit spend around $639b (probably less).  In the old days when the US Treasury used to run with a small TGA at the Fed - its net issuance equaled the deficit spending.  But not this summer.   Not only will the US Treasury not remove that $639b of new bank reserves by adding new Treasury securities -- between it and the Fed, they will WITHDRAW another combined $254b of US Treasuries from the private sector.

 

Unless the debt ceiling moratorium gets extended, that's a lot of cash and reserves sloshing in the system looking for yield.  And they are now starting to crowd at the Fed's reverse repo window.  If the Fed didn't do this, short-term rates could not be supported and we'd start to see negative rates at the short end.

 

Here's some data to illustrate what I'm talking about.

I've divided the pandemic and recovery into several periods.   When the pandemic hit the economy in March - June 2020, the US Treasury unleashed very heavy spending (Stimmie I).  It also more than covered its spending with huge Treasury security issuance in order to run up its Fed TGA.  But the Fed was also out there massively buying Treasuries.   The net result was that about 78% of the spending was covered by net supply of Treasuries (between the Fed and the US Treasury's buying and issuing).   But since the economy was ice cold, demand for US Treasury's after an initial panic was lower too.

But look at the period coming up now (May 21 - end of July 21).  A fast-recovering US economy needs US Treasuries, not just for more yield than cash, but as collateral for increased financing/lending.  But supply is actually going to shrink vs new reserve creation via deficit spending.  

Its no wonder everyone is piling up at the reverse-repo window since mid-March.  That demand is only going to continue to go higher every week.   I think the pressure on yields will also be felt at the long end of the yield curve.  Its no wonder that the yields rising were stopped in their tracks in mid-March (right at the time of that massive one-day deficit due to Stimmie III checks/deposits plus the US Treasury starting to ramp down its TGA).

Happy to answer any questions if I can.

wabuffo

Thanks for taking time to put the details. I am just curious about it. I don't use any of it for my investments, but curious about it.

 

So big picture I am getting here: 

Demand for long end( for example 10 years) treasury was not that high in early part of 2021 and 10 years rates rose as result. Then we had high demand starting from  Mid-March and that put the pressure and yield on 10 years did not go up after Mid-March. What happens starting Aug and why? Demand for 10 years treasury shouldn't go down starting August.

I know you answered it earlier, but something obvious to you is not obvious to me even after reading your detailed post.

 

Edited May 27, 2021 by rranjan

[wabuffo]

What happens starting Aug and why? Demand for 10 years treasury shouldn't go down starting August.

The US economy is too large and complex for single-variable projections.   But I would expect that after August, the supply of US Treasury securities will begin to match deficit spending and Treasury securities held by the private sector will begin to go back up.   All things being equal, long-term yields should resume their rise that we saw earlier in 2021.   That's not a bad thing - the economy is heating up and Treasury securities are in demand as collateral for lending.

wabuffo

[JRM]

Wow.  Thanks for taking the time to explain that.  

[stahleyp]

On 3/14/2021 at 1:05 PM, wabuffo said:

 

 

I'm not making any predictions - but if I did, I'd say Treasury yields go lower and the short-end even goes negative, maybe.  Gold continues to go lower til April and then starts back up.  Stocks roar higher through May or early June.

 

After that comes the great whipsaw.  Yields turn suddenly higher, the air fills with talk of tax increases and the back half of the year is a bit of a rough go for stocks.

 

Of course, this forecast is worth what you are paying for it -- because of course I could be wrong.  And regardless, macro shouldn't matter for stock pickers like us anyway 

 

wabuffo

Look at this guy. Yields are lower (as predicted). Gold hit a recent low at the end of March and has rallied (pretty much as predicted). Stocks are also higher (as predicted). 

 

 

 

[wabuffo]

Yields are lower (as predicted). Gold hit a recent low at the end of March and has rallied (pretty much as predicted). Stocks are also higher (as predicted). 

Rather than quit while I'm ahead - the signal that I will be watching is the US Treasury general account level and waiting for it to fall to $150b or so.   You can follow that level daily at the US Treasury's daily statement website (current TGA level as of May 27th = $746b).

https://fsapps.fiscal.treasury.gov/dts/issues

The one-two growth in reserves from both the Fed doing QE every week and the US Treasury spending without a commensurate level of debt issuance is flooding reserves into the banking system.  This is a one-timer, though til the US Treasury gets to its must-achieve level of $120b or so by end of July.   The banking system is like a big bathtub that has its drain plug in and the water level is rising too high.  That's why there is a recent spike in reverse-repo.  Reverse-repo is the overflow drain at the top of the tub that prevents the water level from flowing over the top of the tub and onto the bathroom floor. 

When the TGA hits target, I think issuance will pick up which will help long-term rates start to climb again.  That should happen sometime in early-mid July.

The last part of this three-act play is to watch to see if the rising yields in August-September start to slow down the advance of the broad equity indicies.  

Of course, I'm not a macro guy and most of the time macro is quite random and hard to forecast.  But every once in awhile, things like this TGA rebalancing is going to have some predictable effects.

Of course, I could be wrong about all this.

wabuffo

Edited May 30, 2021 by wabuffo

[benchmark]

4 hours ago, wabuffo said:

The last part of this three-act play is to watch to see if the rising yields in August-September start to slow down the advance of the broad equity indicies. 

Rising yield might also push indicies higher

https://www.forbes.com/sites/danrunkevicius/2021/03/04/rising-rates-are-great-for-the-stock-market-except-for-these-stocks/

[johnpane]

10 hours ago, wabuffo said:

This is a one-timer, though til the US Treasury gets to its must-achieve level of $120b or so by end of July.  

Are you sure $120b by July is correct? I see you cited a Bloomberg article early in this thread that quotes that number, but others are saying the target may be higher and the deadline later, e.g. $500b, $750b.

 

[wabuffo]

Rising yield might also push indicies higher

Indeed - this is the weakest part of my forecast.  That's why I threw in the tax changes as well.  It is the one-two combo of a rising discount rate PLUS change in the federal corporate tax rate that will pinch stocks.

wabuffo

[wabuffo]

Are you sure $120b by July is correct? I see you cited a Bloomberg article early in this thread that quotes that number, but others are saying the target may be higher and the deadline later, e.g. $500b, $750b.

There is no doubt that the US Treasury is operating under a temporary suspension of the Debt Limit.  Its noted at the bottom of every Daily report.

The legislation was passed by Congress and includes a provision that mandates that the US Treasury's account balance at the Fed must remain at the same level as it was just prior to the suspension.  This is to prevent exactly the US Treasury "running up its balance" while the suspension of the Debt Ceiling is in effect.

Here's the balance as of the August 1, 2019 Treasury Daily Statement:

I'm not sure if its the August 1st balance ($117b) or the July 31st balance ($176b) that holds here - but its still a big drop from the current level.

Where you are probably hearing about other balances is from the US Treasury's quarterly refunding forecast documents.  Here's the latest one:

https://home.treasury.gov/news/press-releases/jy0158

But these quarterly forecasts have been very unreliable in the past and its clear they don't mean much.  And, in any case, there's a footnote/qualifier attached to the estimate.

That's unlikely to happen.  It requires agreement from both the House and the Senate to do this.  Could it happen?  Perhaps.   That's why I qualify my forecast.   But I think its a low probability between now and the end of July.    Still - not an expert on this stuff so I could be wrong.

wabuffo

Edited May 30, 2021 by wabuffo

[stahleyp]

Bill,

So are you saying you still think there will be a rough patch from here until year end? 

[wabuffo]

So are you saying you still think there will be a rough patch from here until year end? 

I think that there will be a big headfake on Treasury yields (first lower, then snapback higher).  Whether that affects equities, I'm not sure...  it all depends on whether the economy is growing quickly well into year end, I guess.   If growth slows and Mr. Market becomes more convinced that big tax increases are coming, then yeah - I think a rough patch might be coming.

If taxes are pushed off due to a stalemate in Congress and the economy continues to rip, maybe not.

I am often wrong though...

wabuffo

[stahleyp]

6 minutes ago, wabuffo said:

So are you saying you still think there will be a rough patch from here until year end? 

I think that there will be a big headfake on Treasury yields (first lower, then snapback higher).  Whether that affects equities, I'm not sure...  it all depends on whether the economy is growing quickly well into year end, I guess.   If growth slows and Mr. Market becomes more convinced that big tax increases are coming, then yeah - I think a rough patch might be coming.

If taxes are pushed off due to a stalemate in Congress and the economy continues to rip, maybe not.

I am often wrong though...

wabuffo

But more often right.

[hasilp89]

4 hours ago, wabuffo said:

Still - not an expert on this stuff so I could be wrong.

Appreciate the humility. But your analysis and insight is significantly better than anyone else’s ever read. And I ignorantly waste a lot of time trying to understand what the hell is going on.

[wabuffo]

saw this in the F-T today:

https://www.ft.com/content/9b32906b-210e-4402-9e3c-0e70f96728f0?segmentid=acee4131-99c2-09d3-a635-873e61754ec6

 

Quote

The sine qua non of a deal on Treasury market reform, raising (or, who knows, maybe abolishing) the debt ceiling will be negotiated between Senate and House Republicans and their Democratic counterparts, in concert with the White House. That will be a tense but familiar struggle, and almost certainly can only be settled at the last minute, probably in October and November.

wabuffo

Edited May 30, 2021 by wabuffo

[wabuffo]

We're hitting a critical point where the Fed keeps buying in the open market while, simultaneously, the US Treasury is emptying its TGA account. The rate of new deposits/reserve creation is outpacing the issuance of new Treasury securities to soak up these reserves.  The US Treasury is not really doing its job 1 - which is to issue treasury securities as a reserve withdrawal function because it must go to the sidelines for the next couple of months.

 

Money-market fund flows are increasing and having to crowd into O/N RPP at ever increasing amounts but not getting any yield.  They also can't break the buck.  So their next move will be gating.  That will force corporate treasurers to have to pay to either deposit funds into MMFs or buy T-bills outright.

 

Meanwhile the Fed has exhausted its supply of short-term T-bills (15-90 days) being lent into the O/N RRP market, it looks like to me.  I'm not sure how it works but lending longer-duration Tsy securities introduces a small amount of mark-to-market risk if there is a sudden move in rates.

 

 

 

The Fed is doing  over $480b in reverse repo (i.e., lending short-term T-bills) but only has $379b of 90-day or less Treasury securities to lend.   O/N RRP should continue to increase due to the factors mentioned above - so the Fed may have to come into the open-market and put more of its buying at the short-end further exacerbating the shortage.

 

By the end of June, early July, the US will start to see negative T-bill rates.   That is something the Fed has said it does not want to see happen but I don't think they will be able to stop it.  This will be temporary through the summer because after the TGA hits target, the US Treasury will resume its normal Treasury security issuance.   That will be a relief valve that should pump the yield curve back up.

 

It will be interesting to see what kind of reaction negative short-term rates get from the Fed and the equity markets.

wabuffo

 

Edited June 6, 2021 by wabuffo

[SharperDingaan]

A negative T-Bill rate means the investor pays the fed (negative rate) to issue them a T-Bill. Treasurers would instead, just buy foreign instruments that defease debt denominated in foreign currency. Get paid for your deposit, as well as reduce your FX translation risk.

 

If/when negative rates arrive, it Implies a higher US stock market, USD devaluation, and more domestic employment as supply chains re-balance. Burger flippers becoming factory workers at something > minimum wage. All a political plus, therefore likely to happen.

 

A lot of major o/g 'entities' are itching to demonstrate their point, re recent ESG actions. Many are forecasting USD 70-80 WTI as the global covid recovery picks up speed. However, there is now an opportunity to both push WTI higher (USD devaluation), and ALSO crack the whip in some places. 

 

SD

Edited June 6, 2021 by SharperDingaan

[wabuffo]

Hmmm - I wonder whatever could be causing this..... 

 

https://www.wsj.com/articles/banks-to-companies-no-more-deposits-please-11623238200

Quote

Banks to Companies: No More Deposits, Please

Bankers say they thought the improving economy would reduce companies’ desire for holding cash, but deposit inflows have continued in recent weeks.

 

 

Edited June 9, 2021 by wabuffo

[stahleyp]

Bill,

 

I know you invest on an individual company level, but, hypothetically (of course) if you were investing from a macro perspective, how would you position things?