Update on Reverse Repos and a Possible U-turn in Fed Policy

By Victor Sperandeo with the Curmudgeon

Introduction:

We provided a detailed explanation of Reverse Repos in a Sperandeo/ Curmudgeon post titled, “RRP’s: Wall Street Newcomers Need a Monetary Education!” This article includes a RRP update with a startling finding you won’t find anywhere in the mainstream media. We also speculate that President Biden will pressure the Fed to end its “higher for longer” hawkish talk and reduce interest rates prior to the November elections.

An Email Exchange About RRPs:

A long time ago associate of Victor emailed him this morning to ask, “What does the reverse repo market tell you right now?” Here was his reply:

There is a great misconception about reverse repos and repos. An Overnight reverse repo (RRPs) is a transaction where the Fed sells a security to an eligible counterparty and agrees to buy it back the next day at a set price. Eligible counterparties include banks, government sponsored enterprises, Fed primary dealers, and money market funds. As money is taken out of the U.S. financial system when the Fed sells an RRP, it is a “drain” or reduction of the money supply which is intended to curb rising prices.

RRPs are a fairly recent Fed tool. The Fed began testing the overnight reverse repo facility in September 2013 and started to implement it in December 2015. When the Fed wants to stimulate economic growth, it allows RRPs to mature, which puts money back into the real economy. That’s been happening since 2023 as depicted by the chart below.

The peak RRP value was $2.425 trillion on 9/30/22 (except for a slight spike on 12/30/2022 to $2.553 trillion for year-end window dressing). Today, there is only $431.29 billion in RRPs.

→ Approximately $2 trillion has been injected into the U.S. financial system via matured RRPs during the last 20 months! That was during the same time that the Fed continued to RAISE the Fed Funds rate, implement Quantitative Tightening (QT) and perpetuate its “higher for longer” interest rate campaign. In essence, the Fed was tightening credit with one hand (higher Fed funds rate and QT) while loosening credit (by letting RRPs mature).

The net increase in financial liquidity is part of the reason GDP has been strong (“no recessions allowed”) and U.S. stocks have been in a bull market since October 2022 (the month after the total amount in RRPs peaked). Victor believes this reflects the Fed’s goal of keeping the economy strong into the November U.S. elections.

Analysis of the FOMC Meeting Minutes and End of Fed’s Hawkish Drumbeat:

The April-May FOMC meeting minutes were released on May 22nd after the markets closed. As usual, the gang talked the markets down by grousing about rising inflation, but left the door open for a rate cut at the September 2024 FOMC meeting. The Fed’s hawkish comments were carried into Friday and the markets had a minor correction, including Gold and Silver.

Victor believes the “higher for longer” Fed comments will stop sometime in June. President Joe Biden’s approval rating is dropping like a stone. According to Reuters, just 36% of Americans approve of Biden's job performance, down from 38% in April. It was a return to the lowest approval rating of his presidency, last seen in July 2022. So, in a month or so, Biden will instruct the Fed to “turn around the Wagon Train.”

The economic numbers will likely get worse until Biden tells the Fed to come to the rescue. According to the CME Fed Tool, there is now a 49.4% probability of a 25 bps or 50 bps rate cut at the September FOMC meeting. We expect that probability to increase substantially next month.

As “The Lone Ranger” used to say “Hi-Ho Silver Away.” That was the theme song of this very popular TV program which the Curmudgeon and I enjoyed tremendously while living in NYC.

Apropos is an episode titled “The Lost City of Gold,“ in which the Lone Ranger and Tonto investigate a series of mysterious murders which have a sinister pattern. Peaceful native American Indians are the victims of a gang of hooded killers. The Lone Ranger and Tonto discover that missing medallions may lead to hidden gold. The Ranger uses disguises as only he can do to piece together clues and expose the outlaw band and bring them to justice. The concept of a lost city filled with gold can symbolize the allure of myths and legends versus the harsh realities of life.

In recent years, the U.S. government and the Fed seem to be chasing dreams and fantasies, while failing to confront the practical challenges and disappointments that come with living in the real world. This is particularly true for out-of-control U.S. government spending (resulting in huge budget deficits) and higher interest rates leading to increased debt servicing costs (which further increase budget deficits and the national debt).

Victor’s Conclusions:

The $130 trillion U.S. bond market (capitalization) is losing its status as a safe haven. U.S. bonds have been in a major bear market since June 2020. It’s being replaced by the $65 Trillion stock market and the $14 Trillion gold market which have been on the rise.

If not for the upcoming November U.S. elections, U.S. 10-year yields would be as high as 6% (vs ~4.5% recently). The U.S. government and the Fed are going to have to create a new trick to manipulate the problems they’ve created with excessive spending, enormous budget deficits and “higher for longer” interest rates.

End Quotes:

As Ollie (Hardy) said to Stanley (Laurel):

“Well here’s another nice Mess you’ve gotten me into!”

Picture Fed Chairman Jerome Powell talking to U.S. Treasury Secretary Janet Yellen saying:

“You can’t get out of here that way. Oh, yeah? Why not? Because the door is over here.” – Oliver Hardy

Laurel and Hardy were internationally famous for their slapstick comedy, with Laurel playing the clumsy, childlike friend to Hardy's pompous bully. Victor says they were the best comedy team in history!

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Be well, success, good luck and till next time……………………..

The Curmudgeon
ajwdct@gmail.com

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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