In today's show, you will learn how the Fed's Standing Repo Facility can be used to dump more government debt onto depositors, how an illiquid Treasury market can send bond prices soaring, why unemployment claims show we are deep in a recession and evidence the stimulus money has run its course.
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What is the Fed's latest plan to dump even more government debt onto you what does an illiquid treasury market mean to bond prices and are there signs that the stimulus has just about run out answer those questions and more on today's macro show I'm your host Steve van Metre and thanks for joining me today because today we're going to take a deep look into the standing repo facility we're going to talk about what it is why the Fed established it and how it should be used under normal conditions but times right now are anything but normal I'm going to show you how it could be a precursor to a balance sheet taper and then I'm going to explain to you why I think it's a big scam between the Fed and the banks to dump more government debt onto you and here's the best part if they do it that way you'll never even know it so let's take a look and talk about what the standing Repo facility is and then we'll dig in to the different scenarios now before we do that I was recently interviewed by Spencer Shearer On The Truth Serum Podcast and you can find that I'll put the link in the description down below if you can see it's a fairly new podcast and I think we could easily put one two or maybe even a three in front of his downloads and if you're into real estate law you might want to check out his other episodes but it's a great interview and usually it's podcasted around the 15 minute mark so it's nice and short and direct to the point all right let's talk about this standing Repo facility that's going on we touched on this in the Wednesday show but we didn't get too deep into it because we didn't have time and there wasn't much of a need but what is a standing Repo facility well let's just establish the difference between Repo and Reverse Repo so we've been talking a lot about Reverse Repo which is too much cash in the financial system so the Fed borrows the cash out pulls it out of the financial system overnight pays interest to the person or we'll use money markets as example to the money market funds it's borrowing from and it provides them the overnight collateral that they're required to have by the financial regulations now that makes sense, Repo, 180 degrees, exact opposite too much collateral which is when you hear the term cloud I think treasury securities of some you know could be bills notes bonds but think treasury securities there's too much collateral in the system and the banks need bonds so what they're doing is they're borrowing cash from the Fed paying the Fed interest on that cash and giving the Fed their treasury securities it's both sides are loans whether it's a Repo or Reverse Repo it is structured as a loan the key part to that is the ownership of the treasury securities does not change hands think of it no different than if I was to lend you my car we do not change the title during the time that you're borrowing it it's still mine it's just yours temporarily and so that's how Repo works it is in Reverse Repo it's done as alone so look so what the Fed created was what's called a standing facility meaning the doors are open if you want to borrow come on in and let's take a look at what they created in their Wednesday press release at the end of their federal open market committee meeting they under the standing Repo facility the Federal reserve will conduct daily overnight Repo operations meaning if you have too much collateral and I know that's not the issue right now but I'm going to show you how how this all connects in against treasury securities agency debt securities and agency mortgage-backed securities pretty much whatever you've got and if you want cash whatever you have will take in on trade with the maximum operation size of 500 billion which is huge the minimum bid rate will be set initially at 25 basis points meaning you will have to pay the Fed to borrow cash 0.25 annualized rate somewhat above the general rate of the overnight interest rate which right now the overnight interest rate is effectively the overnight Reverse Repo which is five basis points or 0.05 percent annualized so annual counterparties for this facility will include primary dealers and will be expanded over time to include additional depository institutions so that is what they created and they also created the same program for foreign official institutions so they can take their treasury securities and they can do the same thing at 20 they can borrow same cash at 25 basis points but they're limited to just 60 billion dollars per night so why would the Fed create this well the real question I would actually have is why haven't we had this before this should in my opinion just should be a standing facility for the Fed because we are the global reserve currency and everybody transacts in dollars so there could be times where you have too much collateral too many treasury securities and you need cash well there should be no reason for people to sell their treasury securities because that's how it works now hey if you need cash and you don't have it well you go out and you sell your bonds and treasury markets fairly liquid in general and you go and you get your cash and you spend it now you can hang on to your treasury securities and this is particularly important because if your treasury securities let's just say your average interest rate on your pool you know maybe you're a large central bank four in central bank is greater than 0.25 then this is not a big deal you can still generate a positive interest but you're going to pay 0.25 percent now let's take a look at how this could be used for to help out in tapering if the Fed were to to do that and we're going to go to the latest report from Zoltan Pozsar at Credit Suisse the global money dispatch because in here we're also going to get into where I think this is going to be turned into a giant scam and I think this is really interesting so our focus as he starts out our focus has recently been to the question of who will buy treasury securities and mortgage-backed securities when the Fed starts to taper QE and that is the really big question and one of the reasons why I don't think we're going to taper right and I have zero expectation that's going to happen but the question is who's going to buy this of course it also depends on what the Fed is going to taper they're going to taper what the banks need which is T-Bills are they going to taper something else but there's at this point there's no risk of a taper anytime soon in my opinion we've shown that the large US banks so this is where Zoltan is really concerned about he said we're shown that largest banks have been mar the main marginal buyers since the beginning of covet 19 with JP Morgan Japanese mega banks seem to have 10-year yield bogey that's meaningful better meaningfully meaningfully better than race during the second quarter around 1.75 percent and RV I'm not sure what RV hedge funds are I do not I don't think it means the thing you perhaps go on vacation in want certainty that basis and Repo rates won't blow out but we do know that JP Morgan and bank of America have been the largest two commercial banks that have been buying treasuries Wells Fargo still being in the penalty box hasn't really done it so remember we've talked you talked about that four engine plane it's really being driven by you know almost two inches primarily one which was JP Morgan so the question the Zoltan's posing is saying like look who's going to buy all these bonds if the Fed does indeed taper which again tapering is the predominant view of the market so this is a foregone conclusion I'm certainly one of the few that do not think that's going to happen so what he says is the standing repo facility is a stroke of genius and this is wait till you see how this is going to be leveraged it generates demand for treasuries and mortgage-backed securities it basically is basically finance quantitative easing as opposed to funded QE so what is funded QE well funded QE is when the Fed buys bonds and creates a permanent reserve so that is something very important to understand when the Fed does QE it purchases the treasury security or mortgage-backed security from a commercial bank which is a bank reserve and makes a permanent reserve in the system that only the Fed can undo but repo's a little bit different let's look at that so finance QE is when the Fed reposts bonds and creates a temporary reserve because remember Repo and Reverse repo right now are both overnight that's the key they're overnight loans so he goes on to say central banking isn't rocket scientist whenever a central bank whatever central bank does is always either Permanent Open Market Operation POMO or a TOMO Temporary Open Market Operation so you have funded QE is POMO finance QE is TOMO now we're going to look here first at how this plays out in a taper situation and then we're going to dig into how the I think this is going to be used to literally as a scan between the Fed and the maid and the big banks let's check this out so finance QE rolled to infinity so it's like I'm just going to continue borrowing cash from the bank every night over and over and over again is like funded QE buying bonds on scale and financing them on scale is the same thing the central bank absorbs collateral so absorbs those treasury securities and puts cash into the system the only difference is one is permanent one you have to pay a borrowing cost of 25 basis points and the question of marginal buyers is resolved so this is critical to Zoltan is it eliminates that question of who's going to buy them we have two standing Repo facilities domestic and foreign we just looked at that the domestic one is ready for dealers to use for intermediation starting today and will give confidence for RV funds hedge funds to harvest emerging bases as taper commences re-apocalypse is no longer a risk he was talking about how you know there could be a kind of domino effect in the markets so the Feds again doing what the Fed is designed to do which is you know put out fires and in this case maybe putting them out before they start the domestic standing repo facility will be ready for bank portfolios of small large by the time the taper commences so here he is he to him this is a foregone conclusion that the Fed's going to taper banks can start access apply for access starting October 1 so you get a suggestion that Zoltan doesn't think there's going to be any taper announcement until after this is all fully up and running you got to ask the question is why should small banks sit on 500 billion of excess reserves again collateral if they now have the means to turn collateral into reserves on demand like the butter heater is a reality so what he's suggesting here is look these banks can take this 500 billion of collateral or treasury securities give it to the Fed and get cash why would you do that because you can lend it out so get the idea here is look you can come get cash it's pretty cheap and hopefully you'll turn around and lend it out so you start to get the idea here that when the Fed tapers should defend I should be should the Fed taper because I don't agree that a lot of other people do is these bonds are going to get into the commercial banking system there's no buyers for it so effectively what's going to happen is the banks are going to buy it and immediately use the Repo facility in a temporary open market operation to get cash back except what Zoltan is saying is there it's actually going to be a semi-permanent because they're going to do it every day they're just going to keep doing it now if you're wondering can you have people doing Reverse repo and Repo at the same time and you're going to say no the answer is yes we've seen it before and even though it might sound weird to you it is possible so now let's go on and I want we're going to set the stage now for how I think the system is really going to be gamed so let's go on and see so he says why should foreign central banks keep 250 billion in the foreign repo pool at five basis points oh well that's a good question right why would somebody park cash for five basis points if there's a better way to do that maybe that better way is buying treasury securities check this out which is a static pool a stable precautionary pool of liquidity we know that that's what Reverse Repo is when they can here you go buy five-year treasury securities at 75 basis points and Repo them for 25 basis points for a few days if you have a sudden liquidity need okay so you get that so I got too much cash right now I park it in the repair facility I get five basis points 0.05 percent it's pretty good considering you know we're seeing short-term T-Bill rates below that or I can go buy a five-year treasury note and there's a reason he listed that I'll show you why I believe that maybe I get 75 basis points what seven and I need cash all of a sudden now I got this I've got this note five year note right I'm getting 75 base points and now I need cash and I may only need it for a few days or a couple weeks and I can immediately flip that note five year note over to the Reverse repo facility the Repo facility paid 25 basis points so I'm still cash flowing 50 basis points on the deal I get my cash temporarily meet the cash issue that I have when that's resolved I return the cash I get my five year note back and I'm still making more interest so do you see what's kind of going on do you get the idea here are you seeing it whether you don't take all this cash and park it in Reverse Repo take all your cash and buy treasury securities because that's what the Fed really wants it's brilliant let's finish Zoltan's piece up and I'm going to walk you through what's kind of going on he goes on to say standing Repo facility makes collateral king once again right because now you want it pays more interest than the Reverse Repo facility and if you need cash you could still get it it's like a payday loan need cash now no problem Fed's door is always open of course with so many excess reserves in the system we are far from the standing repo facility being used so he's saying look it's not it's probably not going to get used right away I don't think so either but its existence will approve the demand for collateral and that means demand for collateral means more people buying treasury securities which is why the fact that the mar the treasury market is going illiquid makes this even more interesting right let's continue on standard Repo facility created set 500 700 billion of demand for collateral at the stroke of a pen the SLRreform and lifting Wells Fargo asset growth ban will improve the pitcher but now we're less urgent so again the Fed may be putting out a fire before starts the standing Repo facility improves demand for bonds let's taper or not all right so now let's go and kind of discuss real quick just to bring you all on the same page what we have with the Reverse Repo and how now we turn this into what I think is a gigantic scam that again if it works you'll never know if it doesn't work you still won't know so the Fed comes out and says hey there's too much cash in the system we know that we know there's a collateral shortage primarily of treasury bills which are 12 months and less in maturity right so the Fed goes out and says we will take all the cash you got and pay you five basis points or 0.05 percent we'll pay interest on we'll borrow it and so all of a sudden we have now a trillion dollars I'll show you the numbers a little bit trillion dollars flow into Reverse Repo what this does is it helps alleviate the pressure because the money market funds which are now which entirely owned T-Bills can let the T-Bills they have on their balance sheet roll off presumably so the banks can buy them because now they have a stable source of interest that 0.05 percent makes a lot of sense but there's part of a problem here is the cloud shortage is going to get worse so if we look at the treasury general account it's going to continue rolling down now and we've officially hit the debt ceiling we know this normally and depending on what when and if congress acts should get down to around you know 250 to 350 billion dollars it might go lower because they have enough money to push the debt ceiling out to late October early November now it's one thing it's important to understand is when and this something I did it took me a while to kind of click with when the when the treasury borrows money it's all done in T-Bells when that money gets spent down the T-Bills are rolled off and they go away so as the TGA goes down we're at say 575 let's say it gets down to 375 well there's 200 billion of T-Bills that are going away if it gets down to 275 there's 300 billion of T-Bills that are going away so the collateral shortage is going to get worse in fact arguably some of those money markets mutual funds might money market fund didn't mean to say mutual funds money market funds which I guess it could be a mutual fund they were going to have a collateral problem anyways so now the banks have too much cash which they can go to the Reverse Repo facility and get five basis points and we talked about how that releases pressure on the system but now let me explain to you how the scam works because the Fed needs the banks to buy more notes and bonds it's what they want and we know the banks are limited and the banks don't want to let's first look at the QE purchases and see why Zoltan mentioned five year there's a specific reason so here is I track the treasury auctions every week or every month and what you see here is two year notes this is the amount the dealers take this is the amount the Fed buys every month so what you're seeing is the Fed's buying more to your notes than there is the dealers are taking they're buying and this is just last month but they're generally buying about them or a little more than the dealers are taking in three-year notes with five and seven they're always short and this is a new QE purchase schedule tenure now you see in the ten year that the Fed didn't buy enough but this varies month to month so there's this is not an indication this is constant the Fed is buying more 20 and 30 year than the dealers are taking the tips don't even matter in this equation the issue is right here the five and seven here are the issue you're seeing about 28 a little over 28 billion that the dealers are getting and there's a demand at least just from the Fed for 12 so you think there's a problem in the five to seven year range and that makes perfect sense so how do you force the banks to buy more five to seven year notes with all this cash they have that they'd rather he would rather buy T-Bills with but we don't have enough T-Bills so how do I get the banks to do that simple I say look you go out and buy a five or seven year old maybe even a ten maybe and here's the rate you're gonna get check this out here is five year rates they're sitting at 70 basis points point seven percent here's the seven year one so here here's the deal banks here's your choice you can either go get five basis points from the overnight Reverse Repo or why don't you go out and buy a five year at a 70 a 7 and 100 or hey if you're bold enough you can buy a tenure at 120 basis points you get that whole yield what a great deal you need cash no problem it's only 25 basis points so if you look at that five-year note take 70 minus 25. what do you get you get 45 basis points the banks still can earn 0.45 yeah that's right 0.45 percent too many decimals in here versus that five basis points in the overnight repo and all of a sudden as Zoltan says it creates demand now how does that force feed debt onto you well simple if you have a deposit in the commercial banking system that the banks can't back with a t bill now they can go by a five to seven year note you'd never know it you don't know they're doing it now then you'll never know it creates demand for that and all of a sudden if they do need cash boom they can flip it back to the Fed in the in the Repo facility and bingo they've got your cash and they're making money on the spread absolutely brilliant so you see I think it's not going to be used the way everyone expects it to I think it's going to be used as the Fed intends it to to off load some of this debt it's absolutely brilliant now how will we know well we'll look at the h.8 which we look at every Friday we'll look at that at the end of the show but let's look at the Repo and Reverse repo and you see today there's nobody doing repo well that's because they don't need cash so if this starts popping up down the road which it might then it suggests what I'm telling you is happening and you can see the Reverse Repo hit a trillion so the Fed's trying to take some pressure off this this here and bring this number back down by incentivizing people now to the banks to go by five to seven maybe even ten year notes and the only other way we'll know is to look at the h.8 where we'll see if they're actually buying more traditional securities now what does this have to do with an illiquid market well that's real simple because we see that this week yields were rocked by a surprise apple bond issuance and in when apple issued announced their issuance treasury yields went up and why is that well think about this you go to an auction and there's and the people that show up they're not very many of them and those that do they don't have you know they're kind of tapped out financially and if prices start to fall bids will go down real quick to find out who has enough money to buy but can that go in the Reverse direction what if you're in an illiquid market where treasuries are right now and there's a new surge of buyers what does that mean for price same difference let's take a look at the economic data I know we're way behind our normal time horizon on here so we'll probably have to skip a few things but let's take a look and see if there's anything in the data Core PCE we've got jobless claims let's take a look at those here we have an unemployment claims initial claim 400,000 creating a baseline now of unemployment killings of 400 000 not good that you know that's recession level numbers here are total pandemic claims which should be going down up half a million 582,000 still 13,000 people on some form of unemployment benefit and I believe we're about six weeks away from this ex from the least of pandemic claims expiring let's take it we'll come back to that next week let's take a look at personal consumption expenditures this is just a different form of looking at consumer prices and let's see what it says in here is a narrower measure than the consumer price index here it is way off the charts at 13.5 percent year over year for June how about excluding food and energy for June 3.5 so these numbers are still elevated but is there signs that the consumers are going to be tapped out well this is a personal savings rate and this runs around you know seven maybe eight percent a year well we're down to nine point four suggesting that consumers have indeed been draining their wallets and their savings accounts so I know you wouldn't think that in money supply which we'll look at next week but let's look at in the data from Friday here and what do we see in the personal incomes we're up 0.1 percent personal spending up one in June so telling you that consumers are spending more than they make well but now we know why they're draining their savings down let's take a look at the H8 what do we have here bank credit up 8 billion securities and bank credit down 16. now what's interesting that mortgage-backed securities which have been trending up fairly consistently we're only down four and treasuries were only down three so this is where we're going to look to see if the banks are adding treasuries and if they're indeed scamming the repo system which I think the Fed wants so going into now the debt ceiling we're seeing the banks drop some of their what are non-mortgage back or the other securities these are not government mortgage-backed or government non-mortgage-backed securities loans and leases all commercial banks up a whopping 25 billion commercial industrial loans down three real estate loans up 14. remember we saw a little spike in refinances that's probably showing up here a little bit consumer loans up six so the consumer still not out of the picture yet cash at the Banksy cash keys building at 84 or 60 yeah 84 billion dollars suggesting that again banks could take this cash cycle it buy treasury notes and then if need be cycle over the Fed and you think about why that makes a whole lot of sense well quantitative easing causes a buildup in cash in the financial system not because it's money pretty not no not because it's money printing because when savers look to put deploy their savings out for a higher rate over time they don't find any options so they hold cash meaning the Fed is giving the banks now every reason to buy more treasury securities with your money that's right you're financing all the spending that's been going on if you didn't think so how the system really works we'll be back Monday of course for the macro show Sunday night for the chart show for those of you who enjoy that I'm Steven van Metre we'll see you then, bye
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