So many dots, so little time. Actually, only a few dots, quite a ton of unearned noise. If we’re talking about dots again then that could only mean doing the same thing and expecting different outcomes. Those blotches are simply what policymakers themselves believe that future will look like, probabilities and whatnot. Thinking ahead, moving them around here or there is supposed to convey changes to or from “hawkishness.”
Yet, we need only go back a few years to re-witness the futility of the exercise. Dots went one way, reality quite the other.
And that reality is the Federal Reserve pretending to be a central bank. True monetary consistency goes in other places, a fact established yet again by one other (actually two) unnoticed change undertaken at this week’s policy meeting.
What specifically happened this week with the rate hike forecasts was by any reasonable standard underwhelming. Didn’t matter, three additional FOMC participants now think the Committee might be voting for rate hikes in 2022. Added to the four who thought the same in March, this means there are now seven leaning this way.
And eleven who still aren’t.
Looking ahead to the following year, 2023, there had been probably the same eleven foreseeing no rate hikes then, either, but now in June the number has dwindled to just five. This is, we’re told, a high degree of hawkishness.
Initially, the bond market seemed to agree. Treasury note and bond yields rose sharply on Wednesday due to the dot issue. And then longer-term instruments round-tripped yesterday, leaving the curve only a bit higher in the middle and near unchanged at the long end.
This isn’t about the rash of recent CPI and PPI figures. On the contrary, even the latest dot plot confirms the Fed’s more rational stance on them. Transitory. If those truly represent something meaningful in terms of monetary inflation and economic overheating rather than the obvious symptoms of the supply shocks they are, then a whole lot more dots would’ve shifted into 2021 instead of a small few into 2022.
The “hawkishness” characterized by the minor change in rate hike forecasts relates to the official (modeled) view of evolving perceptions about downside risks. Believing the economy plagued mostly by this COVID plague, the FOMC has taken account from very real, very good progress on the pandemic and assigned it a much lower probability of interrupting the economic rebound.
Vaccines, reopening, etc.; these are the new dots. Officials are discounting re-infection, and are right to do so.
But are those the only potential downside risks? We’ve asked this question many times over the last thirteen years since. Those at the Fed say, nope, that’s all there is to worry about. Monetary policy has fixed any other lingering issues. All good to go.
Still there is no accountability for all those past times when it turned out not good to go. Inflation and recovery predicted, by dots or other communication devices previous to the plots, no dice when the time came. And in each and every case there remains the same deficiency at its root.
Collateral scarcity, leaving open the door to something worse developing right when recovery should. Collateral shortage, therefore acute global dollar shortage.
Ironically, this week Jay Powell and his group have done us a favor by inadvertently exposing this same issue. While media attention focused on those worthless dots and extrapolated them, badly, onto recent CPI’s and whatnot, the mystery, so to speak, with the reverse repo program (RRP) window only deepened (at least from the perspective of the same mainstream unable to discern what goes on outside of bank reserves).
The commonplace explanation for RRP is that it is a last resort for money market participants to place excess reserves; “too many” reserves, therefore, the need to “soak” them up. From a monetary policy perspective, this gives the central bank a tool to place a floor underneath money markets even in a time of “abundant” reserves.
Who would rather lend in any private money markets at some overnight return less than RRP when with the RRP you’d be undertaking the same secured financing arrangement except with the central bank now as the cash borrower posting collateral to you? In theory, rates would never go below because why would they.
RRP usage has exploded since the middle of March, which, as I’ve noted recently (many times), just so happened to have been the exact same when UST yields on notes and bonds shifted out of reflation. Already something of a direct contradiction; if the conventional theory on RRP holds, then why would an even greater abundance of excess reserves, essentially “too much” money, coincide directly and consistently with anti-reflation across bond markets?
More money, more inflation. More RRP, however, less inflation/real growth priced into bonds.
While there is truth to the common explanation for RRP, that’s not the only one. Yes, there are some, money market funds, in particular, who are having trouble lending excess cash anywhere else. The Fed’s RRP provides these with a floor-like, minimum opportunity that they’ve increasingly gravitated toward.
As a monetary policy tool, the FOMC could change the rate paid on the RRP to raise or even lower this theoretical rate floor. If, for example, money rates across-the-board fall and begin to threaten dropping below any set target or boundary (still using the federal funds market), policymakers might vote to increase the RRP rate in order to move the floor upward influencing other money market rates in the process.
This is just what the FOMC did this week. First, the Committee voted to increase IOER (don’t get me started) by 5 bps to 15 bps total. Next, officials then voted to raise the RRP from zero to 5 bps for transactions beginning yesterday, June 17.
With an actual 5 bps in return, RRP use exploded by about 50% from the day before; $755.8 billion taken out by 68 different financial counterparties.
But even this leaves out half or some good part of their reasoning and motivations. Money market funds or other cash pools love the safety and security of repo markets. Unsecured short-term lending, by contrast, largely disappeared around August 9, 2007, and it has remained this way ever-afterward. So, it’s either find someone in the private marketplace with collateral seeking cash or go to the Fed where the cash sure isn’t needed but has an overwhelming abundance of otherwise unused collateral just sitting there.
What if money market funds begin having trouble finding enough potential borrowers with the right collateral? Then any migration toward RRP wouldn’t strictly be “too much” money but instead some degree ofsystemic “not enough collateral.”
It is here where the increase in the Fed’s RRP rate has done us all a huge favor. Theoretically, it isn’t just that cash lenders would prefer to lend to the RRP at its return than private repo; this should hold for all short-term interbank opportunities. For instance, why would anyone buy a 4-week Treasury bill yielding, say, 3 bps in equivalent yield when they could go to the RRP window and get five?
Hypothetically, this wouldn’t happen. Shouldn’t happen. Think about it from the perspective of the cash lender facing these alternatives: on the one hand, you buy a T-bill which is essentially like lending collateralized by the best of the best collateral; on the other, you go to the RRP, which is essentially like lending collateralized by the best of the best collateral. Three versus five should be no contest.
Yet, yesterday on the raised RRP’s first day, 4-, 8-, and 3-month T-bill yields all traded below the RRP. We’ve actually seen this before, and by raising the RRP the FOMC has made this easier to see.
This is the same imbalance as had become commonplace during the last inflation hysteria a few years ago back during 2017’s “global synchronized growth.” The latter slogan was used frequently to convey the same thing as the Federal Reserve’s looming “quantitative tightening”: for the first time since the 2008 crisis, the economy and financial system had been fully fixed leaving nothing in the way of full and complete, inflationary recovery.
No more false dawns.
While all that talk was going on at the surface, underneath Treasury bill yields had defied the RRP consistently.
How else can anyone explain such a premium on Treasury bills that they would price at a return less than the RRP? That’s really the whole thing in a nutshell; overpricing specific financial instruments when compared to something that is intended to make such overpricing impossible. There must be some other value or valuable utility, one that has become increasingly more valuable, about Treasury bills.
Again, collateral scarcity. It was obvious back in 2017, having written the following in June of that year when T-bill yields didn’t just drop a few bps below RRP they truly sunk underneath:
“To put it bluntly, the Federal Reserve is starting to get the idea that maybe it’s not the center of the money market universe, and may only be one factor among many others (none of which policymakers seem to understand, but some may be getting closer to). It’s one thing to write about it in terms of basis swaps of one kind or another, even the GC repo rate that for almost the whole last ten years has been out of whack. But to find it in the 4-week treasury bill (now 3-month, too) and to such a huge degree is a direct and negative commentary on the RRP and thereby the idea of “rate hikes” …What is actually taking place in bill markets are these other “dollar” dimensions, the distinct liquidity preferences that remain no matter which way the Fed goes proving the greater independence of money from policy. In the specific case of T-bills, we can easily surmise collateral.”
Not merely a problem for secured money markets or money markets beyond those, a trivial quirk unimportant to the wider condition and picture. Rather, this was another key indication that the system remained vulnerable to even small(ish) shocks which, over time, accumulated more than enough probability that an inflationary recovery would have been almost impossible.
Before ever getting off the ground, the monetary system would experience another wave of insufficiencies thwarting the whole thing. False dawn was always the base case with these.
This was, by the way, the position of the rest of the Treasury market, too. The yield curve flattened out even as nominal rates rose (forced up by the Fed’s “confidence” leading to rate hikes at the short end) which was the market agreeing how inflation had no chance; with collateral scarcity perfectly apparent during the “best” times in 2017, something would surely happen deep in the bowels of the system, collateral-wise, before it ever truly got off the ground.
And that explains 2018 (especially after May 29).
Here we are all over again. The Fed is moving its dots “hawkishly” believing downside risks have diminished. And while true of the pandemic, not true of collateral. Increasing the RRP but leaving various T-bill tenors below, Powell has further exposed the naked truth of this same weakness that dates all the way back to Lehman or Bear and just before.
It's never been dealt with, the all-too-high probabilities of collateral scarcity.
This is simply beyond the Federal Reserve’s monetary policy scope because the Federal Reserve is not actually a central bank. Money-less monetary policy instead requires, very much like 2017-18, or 2013-14, pretending nothing bad can happen because…QE or something. Abundant reserves.
Recall, too, how everything changed in markets after May 29, 2018 - in exactly the same way as what had followed after October 15, 2014. Mainstream expectations for inflation and recovery, and the dots in the former moving more and more in that direction, only each time the world coming up very short of those goals. Global monetary tightness, falling yields, decelerating growth and CPI’s, etc., those weren’t just the likeliest outcomes they were made inevitable.
With the same symptoms already visible, now even more visible in the wake of the RRP increase, why would this time end up differently? Thus, the anti-reflation of the Treasury market (spoiler: not just Treasuries, global bond yields have been declining for nearly four months regardless of inflation estimates in whatever consumer or producer price index).
The more the participants go to the RRP, the more anti-reflation because it’s about the money no one knows they should know. Because of this, here we are all over again. The dots are on the move, but so is a lot of other things that have time and again spoiled it for the dots.
