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The Fed is Clamoring to Regain Control of the Repo Markets

From Birch Gold Group

In a week during which the Federal Reserve cut interest rates for only the second time since the Great Recession, the central bank found its hands full with another event with potentially catastrophic implications for the economy.

In short, liquidity in the repo markets – a critical cog in the financial system machine – seized up on Tuesday.

In response, the Fed scrambled to grease the machine with more than $100 billion.

But not before borrowing costs spun out of control.

The Street shed light on some of Tuesday’s market mayhem (emphasis ours):

The New York Fed was forced yesterday to inject $53.2 billion after overnight borrowing costs surged close to 10%, thanks in part to the hefty burden of primary dealers in the Fed system taking down nearly $45 billion each day in gross U.S. Treasury bond issuance, and reducing spare cash — known as excess reserves — at the same time.

This bar graph reveals the 10% spike in rates (at the far right):

bar graph

But Tuesday’s Fed intervention wasn’t enough. On Wednesday, the mayhem continued with another influx of billions in cash:

The Fed on Wednesday poured another $75 billion into the market following a $53 billion rescue by the NY Fed on Tuesday. Overnight lending rates have suddenly spiked, and the Fed is acting to bring them back down to keep markets functioning smoothly.

And then yet again on Thursday came another $75 billion injection.

The Fed hasn’t intervened like this since 2008, which may be signaling that the wheels are finally coming off.

Here’s why the Fed is intervening…

The fed funds rate needs to stay in line with the Fed’s target rate (which it just lowered). If it doesn’t, the intra-bank lending “machine” that is the repo market starts squeaking, and panic can ensue.

According to Agora Financial, “If the fed funds rate veers outside the Fed’s target, the Fed’s words and narratives cease to carry any weight. The emperor is revealed to be buck naked.”

But that begs the question, why did this happen in the first place? The answer isn’t satisfying, nor is it pretty.

Fed Intervention May Start Tipping Dominoes

“Tax payments” and “large withdrawals” are blamed for the sharp spike in overnight rates, according to Federal Reserve Chair Jerome Powell and strategist Michael Block at Third Seven, respectively.

Powell also “downplayed concerns in recent days about a cash crunch in U.S. financial markets, saying the situation says little about the real economy.” Since the U.S. has a real economy, this seems a bit odd coming from the Chair.

Block added, “It’s not clear precisely why that has happened.” One thing that is clear: Any confusion over the exact reason why this happened isn’t a good thing.

But the need for the Fed to keep pumping cash into the system could potentially be even greater than it already is, stoking the possibility of returning to quantitative easing (QE) down the road.

Robert Wenzel thinks that’s exactly what may happen, stating, “If the pressure on short term rates doesn’t ease, the Fed is going to have to make the overnight money pump much more permanent.”

That Fed “money pump” already has a huge balance sheet from the last time QE was used. Who knows how much longer the “money pump” can work?

“This just doesn’t look good. You set your target. You’re the all-powerful Fed. You’re supposed to control it and you can’t on Fed day,” lamented Michael Schumacher, director of rate strategy at Wells Fargo.

If the Fed fails to regain control of the market, this won’t look good at all.

Prepare Your Retirement for a Bumpy Ride

More short-term interventions and a longer-term return to QE could potentially inflate the dollar, burst asset bubbles, and threaten the long-term safety of the economy.

When QE was introduced in 2008, precious metals like gold and silver thrived, and gold continued to power through its biggest bull run in years.

If we’re heading toward that scenario again, it might be a good time to consider hedging your bets now.

federal reserve, financial crisis, recession