Cum On Feel The (Repo) Noize: Repo Rates Stable After Fed Rate Cuts And $500 Billion Purchase Of T-bills, Etc.

Cum on feel the (repo) Noize!

As The Federal Reserve attempted to “normalize” interest rates by raising The Fed Funds Target rate (upper bound) and shrink their balance sheet, all hell broke loose in the repo market (see whites spikes).

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities (Agency MBS, Treasuries). The dealer sells the underlying security to investors and buys them back shortly afterwards, usually the following day.’

Repo rates historically have been near zero %.   But repo rates are now about 20 basis points about the Fed Funds Target Rate (upper bound).

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Here are The Fed’s System Open Market (SOM) Holdings of T-bills and Notes/Bonds.

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So much for The Fed trying to normalize what Bernanke and Yellen did since 2008.

Fed Chair Jerome “Noddy” Powell. Baby, baby, baby!

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T-Dazzle! Is The Fed The New Investment Performance Benchmark? (Hint: All Assets Beat It)

Can you say Treasury-dazzle or T-Dazzle?

Since March 2009, after a massive intervention by The US Federal Reserve in terms of target rate cuts and assets purchases (QE), the S&P 500 index, the NAREIT Equity index and the NCREIF All-property index have zoomed to all-time highs (note that lack of volatility of the NCREIF commercial property index).

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It seems that all assets classes have been “juiced-up” by The Federal Reserve monetary expansion that seems to be permanent. All assets classes can beat it.

And since March 2009, the Treasury actives curve has declined by over 100 bps.

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But over the past 30 years, the best performers have not been real estate, but non-real estate companies.

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Can you say Treasury Dazzle?

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Fed Reverses Course On Balance Sheet Normalization “Temporarily” (Its Always Sunny On Wall Street)

Yes, it is always sunny on Wall Street.  Particularly when The Federal Reserve is running interference like the have since 2007.

The Federal Reserve has reversed course on its unwind of their balance sheet. Allegedly temporarily.

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While The Fed kept rates at 25 basis points for a long time (since 2007), they finally started raising them under Fed Chair Jerome Powell.  And had started lowering them again before an apparent halt.

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Yes, the year-end repo skitter led The Fed to inject > $200 billion of temporary funding for the banks.

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Jerome Powell leading the discussion of Fed policy.

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Fed Policies Lead Pension Funds To Take On More Risk In Direct Lending

The Federal Reserve (and other central banks) have been hyperactive in pushing interest rates to near zero (and negative in Europe and Japan). Here is the Fed’s activity.

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One of the by-products of low rate policies is that pension funds cannot meet their projected payouts to retirees. As a result, pension funds are seeking to take-on more risk in their hunt for higher yields.

(Bloomberg) — Arizona’s $41 billion State Retirement System is looking to dedicate one out of every six dollars it manages to direct lending — more than five times the industry average — in a move some see as a harbinger of what’s to come for the booming asset class.

Investors have plowed hundreds of billions of dollars into private-credit funds in recent years, lured by premiums that are more than five percentage points higher than competing public debt. Yet less than 3% of pension portfolios were dedicated to the sector as of December, according to London-based research firm Preqin. That may be about to change.

In a recent survey of firms managing nearly $400 billion in private-credit strategies, nearly 90% said they expect pension funds to up their allocations over the next three years. The Ohio Police & Fire Pension Fund said this month that it was cutting its high-yield exposure as it moves toward a 5% target for private debt. And in its most recent financial statement, the Teachers’ Retirement System of the State of Illinois said it “continues increasing exposures to private debt opportunities,” even as it retreats from fixed income broadly.

“We’ve been invested in private debt since early 2013,” said Al Alaimo, who oversees the Arizona fund’s credit investments and aims to boost direct lending, one of the most popular private-credit strategies, to 17% of the portfolio, from about 13.6% previously. “We were very conscious that we were an early adopter and we tried to lock up as much capacity as we could with managers we perceived as being the best.”

Asset class returns outpace gains from leveraged loans, junk bonds

Now others funds are catching on, too.

The number of U.S. public pensions active in private credit climbed to 281 this year, with a median allocation of 2.9%, up from 186 and 2.1% in 2015, according to Preqin.

That may not seem like much, but with $4.57 trillion in assets, even incremental increases in exposure can mean billions of dollars in inflows for alternative credit managers.

The Arizona State Retirement System invests with some of the biggest players in the business, including Ares Management, HPS Investment Partners, Cerberus Capital Management, GSO Capital Partners, Oaktree Capital Management and Monroe Capital, according to fund documents.

Of course, other problems plague pension funds, such as in the State of Illinois where people are fleeing due to higher taxes … to pay for their underfunded pension plans.

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Illinois’ pension problems are helping Illinois to have a credit rating one notch above junk. The City of Chicago is already rated as junk along with Chicago Public Schools.

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How long before Illinois jumps on the direct lending bandwagon? After all, it is easier to take on more risk than trying to fix the problem.

 

Zoltan! Underpriced Repo Risks May Push Fed Toward QE4, Zoltan Says

Zoltan!

(Bloomberg) Funding markets are underpricing the risk of renewed turmoil at year-end and the Federal Reserve may be forced to embark on a fresh round of quantitative easing to relax constraints.

That’s the view of Credit Suisse analyst Zoltan Pozsar, who said in a note Monday that the upcoming year-end is “shaping up to be the worst in recent memory.”

The Fed has been conducting repurchase-agreement operations and Treasury-bill purchases in a bid to keep control of short-term interest rates and bolster bank reserves into the system. And while that has calmed markets since the September spike that took overnight repo rates as high as 10%, concerns about the year-end period remain and participants have been flocking to Fed term offerings that will carry them through to January.

If the Fed loses control of overnight rates in the weeks leading into year end, Pozsar said the central bank’s options could include a fourth round of QE, which would involve switching from bill buying to purchases of coupon-bearing debt. It could also encourage foreign central banks to use foreign-exchange swap lines, he said.

The repo market, which relies heavily on just four big U.S. banks for funding, was upended in part because those firms now hold more of their liquid assets in Treasuries relative to what they park at the Federal Reserve, officials at the Basel-based institution concluded in a report released Sunday. That meant “their ability to supply funding at short notice in repo markets was diminished.”

Here is CB excess reserves and all CB holdings of Treasuries and Agency Securities.

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Will The Fed force commercial banks to reduce excess reserves? 

Or let “Greenspan’s ghost” haunt the financial market?

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Thanks to Jesse of Cafe American for his great imagination!

The Unwind of the Fed Balance-Sheet Unwind May Be Buoying Stocks

May be? How about definitely, along with improved expectations for economic growth.

(Bloomberg) — The Federal Reserve says that its Treasury-bill buying program isn’t the same as quantitative easing. But the advance in U.S. equity prices alongside the central bank’s growing balance sheet suggests to some that the effects may not be wildly different.

The central bank, driven by the need to tamp down problems in funding markets with liquidity injections, has expanded its balance sheet from as little as $3.76 trillion at the end of August to $4.05 trillion. That growth has, in effect, already reversed close to 40% of the shrinkage that the Fed began in late 2017. The S&P 500 Index, meanwhile, has climbed more than 7% since the end of August and this week reached new record highs.

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To calm funding markets and improve its control over short-term interest rates, the Fed has used measures including the implementation of repurchase-agreement operations and a $60 billion per month program to acquire T-bills. Officials argue that the T-bill buying isn’t QE because, unlike several of the central bank’s previous asset-purchase programs and reductions to its benchmark rate, it isn’t aimed at lowering long-term borrowing costs and affecting the economy.

Peter Boockvar, chief investment officer at Bleakley Financial Group, says that in the eyes of the market this is just semantics.

“Markets view any increase in the size of the Fed’s balance sheet as QE,” he wrote in a note to clients on Monday.

Stocks, have of course, also been buoyed by other factors, ranging from an improving outlook for global growth and the prospects of a U.S. China-trade deal to better-than-expected earnings and the Fed’s three quarter-point rate cuts this year. But previous QE episodes were certainly instrumental in helping to fuel the post-crisis rally in equities, and signs of history repeating could well be adding to market buoyancy.

Of course, continued robust consumer consumption is helping.

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But California Democrat Eric Swalwell insists on saying “Everything is NOT beautiful.”

Did Eric Swalwell just out himself as Adam Schiff’s whistle blower in the Trump investigation??

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Fed Warns Prolonged Low Interest Rates Could Spark Instability (NOW A Warning??)

You gotta love The Federal Reserve. After 11 years of interest rate repression, The Fed now admits that continuing low interest rates could spark instability.

(Bloomberg) — Continuing low interest rates could dent U.S. bank profits and push bankers into riskier behavior that might threaten the nation’s financial stability, the Federal Reserve said in a report released Friday.

The latest version of the twice-yearly report, meant to flag stability threats on the Fed’s radar, highlighted the rate squeeze facing banks and insurers, noting that it could erode lending standards.

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“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers, and other financial intermediaries could come under stress and spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the U.S. central bank said in the report.

Fed Chairman Jerome Powell suggested to lawmakers on Thursday that low interest rates might be a permanent part of the economic landscape.

“We’re in a world of much lower interest rates,” he told members of the House Budget Committee. “That seems to be driven by long-run structural things and there’s not a lot of reason to think that will change.’

Fed Governor Lael Brainless said in a statement Friday that the low-for-long environment “and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.”

The bulk of the work on the report was done before September’s repo market tumult, which prompted the Fed to pump reserves into the banking system to boost money market liquidity. Still, the report does briefly address problems with the short-term repurchase agreements.

“Pressures in the repo market spilled over to other markets, including the federal funds market,” the report said. “The Federal Reserve took a number of steps beginning in mid-September to maintain the federal funds rate within its target range and to ensure an ample supply of reserves. Pressures in short-term funding markets subsequently abated.”

The central bank appeared to take a more relaxed view of the rising stock market than it did in its last report in May.

While equity prices remain high relative to corporate earnings, they are consistent with the low level of interest rates, the Fed said.

“Over the past couple of years, equity prices have been high relative to forecasts of corporate earnings,” according to the report. “However, other measures of investors’ risk appetite in domestic equity markets are in the middle of their historical ranges.”

You mean like the Shiller CAPE (Cyclically Adjusted Price Earnings) ratio … that is near the level seen on Black Tuesday of 1929.

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And then we have former Fed Chairs Ben Bernanke and Janet Yellen who kept The Fed Funds Target Rate (Upper Bound) at near zero from late 2007 to late 2015 (and then FINALLY raised the target rate in Dec ’15).  As Meryl Streep uttered in Death Becomes Her, “NOW a warning?”

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And then we had the joint rate-repression regimes of Bernanke and Yellen. Note the decline in the 10-year Treasury yield from over 4% in 2008 to under 2% today.

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Yes, The Fed has suddenly come to the realization (after 11 years of low-rate policies) that low rates can spark instability.

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US Treasury Yield Curve Un-inverts (Can’t Turn The Fed Loose) Sag Gone In Treasuries, Not Swaps

Federal Reserve Chair Jerome Powell has said that the US economy is in a good place, and further rate cuts are not warranted. That is, Trump can’t turn The Fed loose.

Various US Treasury yield curves are un-inverting and are all positive.

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The Treasury actives curve is no longer sagging, but the Dollar Swaps curve continues to sag.

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But in terms of Treasury futures, the volatility for 2 year, 10 year and 30 year (Ultra) contracts   are progressively warping for 10 Delta Puts as maturity increases.

2-year:

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10-year:

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30-year (Ultra):

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Every investor needs The Fed to keep propping up asset bubbles!

Of course, the yield curve can revert to a negative state if … the China trade agreement becomes unglued, Democrats succeed in impeaching President Trump, etc.

 

Giddy Up! Mortgage Refis Decline Most In Three Years (Fed To The Rescue?)

According to the Mortgage Bankers Association (MBA), mortgage refinancing applications declined the most in three years on a slight rise in mortgage rates.

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Of course, some of the decline is due to smaller pool of eligible borrowers following a “refi wave.” But still, The Federal Reserve may be prodded into action like in the song “Elvira.” Giddy up!

The MBA purchase applications index fell by 3.5% from the previous week, which is understandable since it is October and the October Country from home sales and purchase applications.

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Actually, it is somewhat surprising that purchase applications are rising despite the decline in “subprime” (FICO < 620) borrowers.

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Yes, it is The October Country for mortgage purchase applications which normally peak in May then decline.

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US Existing Home Sales Decline 2.2% MoM As Mortgage Rates Tick Upwards (Median EHS Prices Fall)

After watching NY Jets’ QB Sam Darnold’s disastrous game against the NE Patriots (he claims he saw ghosts!), the existing home sales report from the National Association of Realtors is a moderate success!

US Existing Home Sales declined 2.2% MoM in September as mortgage rates rose slightly.

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The median price for existing home sales fell as EHS inventory continued its seasonal decline.

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Perhaps Sam Darnold should join the cast of Supernatural as a hunter instead of throwing 4 interceptions and a fumble.

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Let’s hope Browns’ QB Baker Mayfield sees open receivers and not ghosts against the Patriots on Sunday!!