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Why doesn’t the market care about these inflation reports? First, by writing “market” I mean actual markets in bonds. Despite now three huge CPI’s in a row in the US, and an equal number of PPI’s even more obscene than those have been, bond yields are falling. In some places in the bond market, on the verge of tanking.

This is the opposite of what’s supposed to happen; presuming you believe, like you’ve told, these CPI reports are going to continue well beyond the trio. On the contrary, the verdict as viewed from (global) interest rates is on the verge of near certainty; they are not going to continue for much longer. In fact, a perchance worse fate than “inflation” simply fizzling out.

But why?

Primarily collateral. There is a growing scarcity that feeds back on existing and worsening concerns relating to the (true) state of the global economy. Not enough collateral, strains in economy, shortly thereafter even less collateral. Serious enough imbalances emerge, and each becomes self-reinforcing.

Anyone watching closely has seen this same process play out already four times over the past fourteen years. The reason the weak inflation “case” is considered at all, let alone as the accepted baseline in the media, is lack of awareness about what really happens in the monetary system and why. Starting right here.

Inflation, real inflation, is always a monetary phenomenon and collateral fluidity money’s major modern component. Thus, quite simply, if there is serious potential for trouble in this expansive piece, then the market will look ahead discounting more on the probability of trouble no matter what any current CPI, PPI, or PCE Deflator number.

And the more trouble, the more discounting lands in that favor. Yields fall; even tank.

In 2021, collateral scarcity has reached such alarming proportions that even the Federal Reserve’s Chairman admitted it was an issue testifying before Congress. Yes, you read that correctly – though not a single word of it, that I’ve seen, has made its way into the mainstream media which has spent years lapping up bank reserves and QE’s.

This stuff is all on the other side in the shadows. Very near the end of his 3-hour marathon Q&A with the hapless Representatives in the House, Congressman French Hill of Arkansas asked Mr. Powell about his reverse repo program (RRP) that people have been talking about for reasons they really don’t know why.

The politician’s question was formulated from the same mainstream perspective about RRP’s sudden (since mid-March) explosion of activity (very near $1 trillion at the end of Q2). In fact, I doubt anyone, even those somewhat familiar with the Fed and its RRP, are aware there is another perspective at all.

High-levels of usage are, if you look it up on Investopedia, the problem of “too much money”; too many bank reserves being “printed” up as a matter of too big QE. To keep money markets in line to policy targets, the “too much” must be “soaked up” which is what the RRP purportedly does.

Since Congressman Hill’s preceding question was about the on-fire housing market, you could already see where he was going in following up Powell’s milquetoast answer to that one with another one on RRP mania.

Isn’t this all too much money, the Rep asked Powell. No, answered the Chairman:

“CHAIRMAN POWELL. You could say there is a shortage of safe short assets…So, yeah, that’s why that’s happening [RRP], there’s a shortage of T-bills, not a lot of T-bills…”

The reverse repo has collateral coming back (to the cash lender), meaning that it is a quasi-Fed substitute for collateral-starved in a collateral pinch.

Now, you can argue and claim that Chairman Powell is quite purposefully defending his turf by passing the buck (in this case, borrowed UST bucks). Don’t blame QE, he’s implying, rather blame Janet Yellen.

The Treasury Department has been forced into reducing its own borrowing activities, especially the issuance of Cash Management Bills, due to the expiring debt ceiling. The refunding of bills, after the last year having flooded the world with them (unlike bank reserves which went nowhere), amounts to one part of a big change in the availability of bills – which, as a reminder, just so happen to be the best of the best of the best collateral in use anywhere in the world.

Which, if you think about it, really means Chairman Powell wasn’t really laying blame at Yellen’s Treasury Department doorstep, he’s slyly putting this all back on Congress.

Outside of this political dance maneuver, it’s irrelevant. The fact remains, scarcity of collateral that’s become so extreme it has reached the RRP and forced the Fed’s leadership to acknowledge this.

So what?

On the same day, Thursday, as Powell was jostling with Congressman Hill, the Fed’s New York branch (FRBNY) put out a blog post (Liberty Street Economics) on the subject of…collateral (Intraday Timing of General Collateral Repo Markets). Well, they didn’t mean to focus in on collateral, intending it to be more about repo at large, but ending up with its own inadvertent further tribute to this primary factor anyway.

The article spilled the results of what Treasury’s Office of Financial Research had found using confidential intraday repo market data drawn from FICC’s DVP repo operation, as well as the smaller GFC repo market (no data, however, on either triparty repo or the vastly larger and near-completely opaque bilateral, bespoke global marketplace). In both those repo buckets examined, particularly, FICC DVP, most of the repo activity is finished up before 8:30am (ET) each day.

There are several posited reasons for this, but a key one (as even the mainstream authors admit):

“More recently, repo market participants have highlighted an early morning ‘scramble for collateral due to an overabundance of cash. This imbalance has several drivers, including less interest in cash borrowing (and thus providing collateral) by levered accounts, the continued increase in cash availability amid money-market fund inflows and rising aggregate reserve balances, and Treasury bill paydowns. This has resulted in an increase in more early morning and negative-rate trading as dealers are willing to incur negative cash lending rates to obtain collateral. Indeed, negative-rate GC trades throughout the first quarter occurred earlier in the daily session than zero- or positive-rate trading as shown in the next chart.” [emphasis added]

Of course, this “scramble for collateral” is attributed to “an overabundance of cash.” Further, it is wrongly ascribed as “more recently.”

At this stage, you need only put together Powell’s Thursday explanation for RRP with FRBNY’s same day breakdown of early morning repo imbalances. You don’t end up with “too much money”, but you do find, consistently, and not just 2021, “scramble for collateral” when and where collateral is scarce.

The best example of this is none other than March 2020 when, for one thing, the “too much money” hypothesis wasn’t any real possibility. Quoting my own work, as I so often do, from March 20 last year:

“Negative bill yields are further clarifying and demonstrating the usefulness of those instruments beyond any investment or carry trade function. They have a separate utility that is, at times, of enormous value. Financial counterparties during those times are willing to pay a penalty, either the negative yield or the opportunity cost of not using the RRP, this week both, in order to secure and hold on to bills.

“I’m obviously talking about collateral for use in repo markets. T-bills are the most pristine of pristine collateral; always on-the-run therefore liquid beyond anything else, and containing very little interest rate let alone credit risk because of their short-term nature. It doesn’t get any better as far as any repo counterparty will ever be concerned.”

That’s not all; here’s the kicker, a fact and factor that has been obvious and available for more than a decade without any need for the government to take its time sifting through “confidential” data:

“On each of these major liquidation days [March 2020] in the stock market we observe the unusual correlated behavior in Treasury bills. In the early morning hours, beginning before markets open for the day session, bill prices are bid sky high (therefore the equivalent yields, shown here, plummet way, way below the RRP – and this week below that and zero).

Scramble for collateral, therefore, not in any way exclusive (nor in any reality) to “too much money.” On the contrary, when collateral scarcity intersects dealer shyness then becoming a full-on, deflationary collateral shortage, that’s just when deflationary money conditions develop more completely! Even stocks are no longer immune, being subjected last year to some of that market’s worst days on record, each one tied back to lack of liquidity due to repo collateral shortages.

In other words, if you’re a Fed chief and you’re sitting there staring at a Congressional interview into a pre-existing collateral shortage, regardless of where it came from, and you aren’t gravely concerned about that more than any other thing in the money world, then you aren’t a central banker. You instead must direct the most sinister puppet show ever devised by corruption.

This is because time and again collateral is what we see; not just on specific days in the early morning trading as repo goes wrong. Repeated as in terms of these monetary cycles, too, each one incorrectly diagnosed because Jay Powell, apart from yesterday, will focus the public’s limited attention on abundant bank reserves as if the latter means something meaningful. It doesn’t.

There was May 29, 2018; developing the same way, right from the early morning, when clear and obvious (to anyone outside the central bank orbit and its anachronistic worldview) collateral imbalances created a buying panic in UST’s (and other sovereigns, too, such as German Federal Debt instruments; global money, after all). A “buying panic” is same thing as saying “scramble for collateral.”

This was then swallowed up in the media as entirely unrelated, something to do with the Italian Finance Minister’s political fiasco (I’m not making this up, no matter how much it sounds like I am). Because the mainstream view is held to QE being accommodation and bank reserves being something like effective liquidity, any collateral problem let alone such a big one, no one can possibly understand it and its serious, seriously negative potential.

How can there be serious deflationary pressures when “everyone” from the top down says inflation, growth, and more than abundant liquidity?

Mere weeks later, with no Italians in the news, the eurodollar futures curve inverted signaling just how serious these negative money factors had gone. Where inflation was supposed to accelerate, and recovery, too, instead the global system increasingly sapped of needed monetary resources quite predictably went afoul real quick (in a matter of months).

Before that one, back in October of 2014, on the 15th of that month, same exact thing. Mainstream view of rising inflation, overheating due to 2014’s “best jobs market in decades”, creating a conventional picture of “hawkish” monetary policy with rates heading toward the sky. Instead, from very early in the morning on October 15, another immense “buying panic” in USTs completely contrary to what “should” have been happening.

No big deal, everyone said, since Janet Yellen (back when she was leading the Federal Reserve) assured the public there was plenty of bank reserves and the recovery was looking strong if not still too strong. Treasury agreed, writing a full-length report about October 15 and attributing what was a clear scramble for collateral as nothing more than cascading errors in computer trading in the Treasury market.

Seriously, I’m not making this up.

So far as interpretation is concerned, you can easily forgive the public from being so badly misled. Central bankers know what they are doing, we’re told from the very beginning. If they say X, then why would anyone believe any other outcome but X.

How about when Chairman Powell suddenly admits X = collateral scarcity? Or when FRBNY, almost out of nowhere, points out and wonders this scramble for collateral thing-y? A puzzle for a puzzled public being fed a steady diet of inflation figures and inflationary rhetoric.

Nothing of the kind for the bond market which is made up of the monetary institutions and participants who would make actual inflation, if it were ever to get made, and, most important of all, those doing the scrambling for collateral and being stunned by its negative effects time and time again for the inability of anyone on the outside, including “monetary” officials, who still don’t really get it even now.

Jay Powell’s testimony, like FRBNY’s blogpost, merely scratching the surface of a far wider monetary constituency that has existed for decades far beyond his or each of his predecessors’ limited grasp.

Falling bond yields - flight to safety if you must, but even using that term misses the crucial elements causing it – are those in the sights of collateral scarcity becoming more dependably wary of the rising probability for scarcity turning into outright collateral shortage that then unleashes the dreaded and deadly worst scrambles for collateral (and the fire-sale liquidations that come with them). All these things made even more likely as they reflect into, and back from, growing economic uncertainty (see: China; RRR).

A higher probability, therefore, of deflationary, negative circumstances at some point may be just over the horizon. Price deviations in consumer and producer prices here and now just don’t matter (in macro terms; I understand the hardships these create especially for those stuck in the foul end of the malfunctioning global economy).

As I wrote, you really don’t need access to confidential, private information to lay it all out and understand what’s really going on and what’s been going on for a very long time. What you need to realize is that even central bankers are finally beginning to realize they really might be missing big chunks, too.

Once you set aside the limited ideology of Economics, and take only the mountains of evidence, the decades of history behind them, there really are no surprises. After all, the same damn pattern repeats again and again. It is doing so right now. The next thing to look for is another May 29 or October 15. All the ingredients are present at present.

Even those at the Fed can see them, if they don’t yet come close to fully grasping just what it is they’re finally seeing or, more to the point, what it could really mean. And that’s not much, if any, chance for inflation. 


Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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