Role of the Fed in Increasing Liquidity
By Victor Sperandeo with the Curmudgeon
Global liquidity is the primary driver of asset
prices, depending on supply and demand of the underlying asset. Money and credit increase liquidity, and that
directly affects asset prices. Contrary to popular belief, interest rates are a
“paper tiger,” as Milton Friedman and the Austrian School of economists have
noted for over 70 years.
The Duplicity of the Federal Reserve Board:
The Fed is responsible for U.S. monetary policy which largely determines
the amount of money and credit in the financial system. Importantly, the Fed
now tries to hide what it’s doing to better control its narrative (e.g.
“fighting inflation”). As the world now
watches the Fed’s Balance Sheet like a hawk, it uses other methods and entities
to accomplish its goal (which we’ve stated involves an unknown, hidden agenda).
Recently, the Fed has been adding liquidity to the financial system via Reverse
Repos (aka Overnight Reverse Repurchase Agreement or RRP) and the Bank
Term Funding Program (BTFP). At the
same time the Fed is reducing its balance sheet via Quantitative Tightening
Repos and reverse repos are conducted with the Fed’s primary dealers via
auction. A reverse repo (RRP) is a transaction in which the New York
Fed, under the authorization and direction of the Federal Open Market Committee
(FOMC), sells a security to a dealer with an agreement to repurchase that same
security at a specified price at a specific time in the future. For these
transactions, eligible securities are U.S. Treasury instruments, federal agency
debt and the mortgage-backed securities issued or fully guaranteed by U.S.
When the Fed increases RRPs outstanding, it temporarily
drains reserve balances from the banking system.
When the total amount of RRPs decline, the Fed pays back
those dealers and thereby increasing bank reserves.
-->We explained repos and reverse repos in great detail in this
Curmudgeon post. As of
January 26th, there was $570.828 billion invested in RRPs vs 2.375
trillion on March 31, 2023. Indeed, RRPs
outstanding have been in a clear downtrend for the last 12 months as shown in
the graph below:
Another Fed facility of obfuscation is the Bank Term Funding Program
(BTFP), currently at $167 billion. Like RRPs, it is not on the Fed Balance
sheet where it belongs, but separately structured into a PROGRAM. The BTFP is being tapped each week to take
banks' bad assets off their balance sheets, and in exchange, they receive
reserves equal to the par value of those distressed assets.
Swap lines with other Central Banks are
also hidden, and not easily seen or measured.
Two more back door Fed liquidity adds:
The Treasury General Account (TGA) [1.] rose
from $61,952 billion on 5/24/23 to $799,358 billion on 1/24/24 (that’s > 12x
Bank reserves rose from $2.830 Trillion on
January 4, 2023, to $3.526 trillion on January 24, 2024 (that’s +24.6%
Note 1. TGA is a program that provides services that
accept cash and check deposits, including foreign items, from federal agencies.
Banks and credit unions that the Bureau of the Fiscal Service has accepted into
the TGA network take in over-the-counter cash and check deposits from federal
It also should be realized
that QT (reducing the Fed Balance Sheet by letting bonds “mature”) does
nothing to lower inflation. Matured bonds
are merely re-sold to others to replace the money paid out by the Treasury to
the Fed. Notice the Fed NEVER SELLS
bonds! That would be TRUE QT.
Financial conditions in the
U.S. have eased considerably recently and the RSM US Financial Conditions Index
has moved into positive territory as per this chart:
However, there should be four negative
liquidity factors coming later this year: the BTFP will expire in March,
bank lending practices will remain negative, the RRP facility will be emptied,
and the Fed's Q.T. program will remain in effect (even if it is slowed down or
Hence, there should be a significant
decline in U.S. financial liquidity, which coupled with the Treasury’s
increased borrowings (to fund the huge budget deficit) could cause turmoil
in the long end of the bond market (where rates have risen this month) and
possibly a sharp correction in equities, especially the Magnificent Seven.
The Fed is trying to sell the
markets a sham: that its balance sheet is decreasing, they aren’t ready to
lower their policy rate yet and U.S. monetary policy is still “tight.”
Instead, in a back doorway,
the Fed is adding massive amounts of liquidity to the system. As a result, many Fed watchers are
“flimflammed.” It’s like saying, LOOK
HERE, but don’t look over there.
If you add up the balance
sheets of global central banks you get about $30 trillion, according to Michael
Howell (a maven on measuring liquidity).
I recommend his book “Capital Wars” for a discourse on how to view
liquidity, which is what moves assets and markets.
In addition to watching the
Fed, Howell suggests keeping an eye on the People’s Bank of China (PBoC). From mid-2023, it engaged in large-scale
operations that injected some Rmb6.2tn ($850bn) into domestic money markets,
reversing its previous tight stance. This is local currency credit, but he
argues it is partially fungible and helps explain large capital outflows from
China to other financial markets. The PBoC contributed almost one-fifth of the
total increase in global liquidity last year.
The soothsayers who forecast
the financial future mostly look at PAST ECONOMIC DATA to predict FUTURE
trends. Perhaps they should watch the
markets to predict the future of the economy.
“When coming events cast their
shadows, those shadows fall on the New York Stock Exchange!” Charles Dow, William Peter Hamilton, Robert
Rhea, and Richard Russell (all famous Dow Theorists).
Wishing you success, good
health, and good luck. Till next
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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