Another great writeup, thank you Bear!! Theoretically, couldn't the fed help facilitate reducing MMF reliance on the RRP by either reducing the offering of treasuries eligible for the overnight rev repo agreement through their own policy, or reducing the total pool of treasuries on their balance sheet so there simply isn't a supply there to support the current RRP demand (maybe the Treasury is the buyer)? The later would have to be an open market operation I presume?
Absolutely, the Fed could help if they wanted to. They could reduce the counterparty limit for RRP usage, they could lower the RRP rate, they could stop QT, etc.
Its not that they aren't capable of helping, its that they WANT to tighten. Meanwhile the Treasury does not have the same mandate or objectives. The Treasury wants stability in the treasury market and lower long term rates for debt issuance, and they don't have the duty to fight inflation. They are working with a different set of tools and objectives.
Great write up. Thanks for making a difficult topic easier to understand. My impression after reading through twice is that, in terms of “inflation control”, the Fed and Treasury are working against each other. Seems... inflationary. Is this correct?
Other-things-equal, the goldilocks scenario above would be "inflationary", though perhaps not as much as the QE+stimulus during the pandemic, if there isn't as direct a route for turning financial liquidity into regular economy spending. (Fiscal stimulus effectively mainlined the QE monetary expansion into the economy during COVID).
But even with this distinction, you are correct, that the Fed and Treasury are in conflict. The Fed wants to tighten financial conditions (with a lagged impact on inflation), while the Treasury is looking to loosen financial conditions.
I'm not expert, but I'll just weigh in with my opinion. I'm not so sure it would be inflationary. Yes, it could cause risk assets to rally, but I'm not positive that would translate into the real economy? Just like we had 10+ years of QE induced asset price inflation with little inflation in the real economy. Furthermore, the outcome here is that short term rates get jacked up, which I can't see as being a great boon to inflation.
That's just my take and I could be completely wrong.
Its hard to just look at QE in isolation and have an accurate prediction of the immediate effect. In 08, it was a crisis prevention tool that recapitalized banks but did not lead to a huge expansion in money supply. 2011-14 QE was a growth policy, but it wasn't paired with fiscal stimulus - therefore I think it took much longer for that financial money to trickle down to the economy, though I believe it absolutely did over time. During the pandemic QE funded direct helicopter-money stimulus and therefore you saw a much more immediate effect on economic activity and inflation.
This treasury buyback scheme, if it works as intended, would probably be most similar to the QE of 2011-14, but at the same time it is fighting against headline QT by the Fed.
The best analogy I think of is that QE is like a drug - it depends on how you take it. Strict QE is like ingesting amphetamines (Adderall), while QE+Fiscal stimulus is like smoking amphetamines (meth). The transmission mechanism is much more immediate and disorderly as a result.
Thanks for the response. Your reasoning makes sense although with the closet QE I do grow concerned about a continued misallocation of capital toward paper and away from real assets focused on real production. Which, in the long term, I feel is a source of inflation as the global economy reorganizes. Frankly it doesn’t seem that anyone in the halls of the Fed or Treasury has a good grasp on the long term consequences (especially the second and third order effects) of toying with money in an attempt to manage our economy. It is all too complex and dynamic for any human brain to grasp.
I agree with these concerns, and would argue that the Treasury/Fed is aware of the long-term concerns but are much more worried about the immediate future (even if it makes the long-term consequences worse). This is the definition of short-sighted policy, but that is a common problem across many policy spheres.
It doesn't appear that anyone in any government office anywhere has an eye toward second and third order consequences. Right now it seems like the government just lurches from one disaster to the next, never being proactive, just playing cleanup by throwing crap at the wall and hoping some of it sticks. Not enough diesel? Just ban exports to Europe! So simple. What possible repercussions could there be?
I do agree though, that failing to allocate to the real economy could lead to inflation. There are so many factors that go into all of this that's it's awfully difficult to be sure of any outcome.
Thank you for the wonderful article, Mr Bear. I just became a new subscriber :)
One question please: in this buyback program, the Treasury would be buying off the market a bunch of old T-bonds at a huge discount compared to par. Some of those T-bonds are trading at 60 cents to the dollar!
Granted, the newly issued T-bills must offer a higher yield than the old T-bonds, but the Treasury would be effectively exploiting current market prices to reduce its total debt burden while it's cheap. Great move!
ha that’s an interesting thought I hadn’t considered - if they are buying long dated bonds back in the open market, they will be buying below par because of the interest rate increases this year. But they would be financing it with new bill issuance at even higher rates, the net interest burden of the treasury would still increase even even if there is some sort of “gain” associated with the buyback.
That is correct: they would have to pay about 3% higher yield on the newly issued debt, but they will be buying off the old debt at a 30% or 40% discount to par. Maybe they have run their numbers and it is worth it? :)
loved the: In the end, some people end up with tokens, some with money.
The way these companies pump the coins amazes me. They use influencers, manufacture whole communities and even fashion models.
The interesting thing is that part of the people that buy into these schemes are ones you would think of as the "smart kids" - college educated, tech-savvy that have all the "right" ideas.
One person that convinced his girlfriend to invest along with himself in Terra was a cybersecurity expert... Great stuff.
Thank you sir! Though I think this comment landed on the wrong article!
I agree. I think we all will look back on this period with a bit of wonderment - like did all that stuff really happen? will be fun to explain to the next generation
As someone pointed out here and as can be read in other economic write-ups there's a theory that the genie of "neverending QE" has unleashed a very "real need" by the financial "economy" for liquitidy to "never end" - the system right now is bascially showing signs of going cold turkey from a liquidity rugpull as you describe.
Inflation is not doused and is a lagging indicator - if and when the QT should be showing effects based on technical rules is probably best viewed when looking back to Bernanke and some more technocratical Fed Chairmen who seemed to follow what was later coined the "Taylor Rule".
The rule itself is arithmetic trying to balance fed funds short rates vs. CPI and other factors - here is a great chart comparing real rates to the ruleset rate - data only going to 2020 unfortunately here (FRED):
And here's word from the man himself on what we are all witnessing in the current monetary policy environment, which has been on "neverending QE & money tap" since 2010.
Ben Bernanke - infamously famous for being amongst the FED Chairmen who pulled out the "full stop" in their arsenal and reacting hard and fast to inflation to try to stop it cold in its devastating tracks in the heydeys of a boom and bust cycle in the 80s was putting rates at above 18% at one point (!).
I think many here did not witness this period and how devastating the energy shock of the 70s was to fuel the later inflation curve.
HEre's some words from the man himself on what we are currently seeing in the monetery policy field - aka Biden's appointed Fed Head Jay Powell's and commitee are probably way behind the curve already:
What the FED is doing now is balancing precariously in-between dousing the financial market itself, who since 2009 has become in effect an addict expecting infinite money to be shoveled, to remain with your "Furnace" comparison of an earlier essay.
Since a lot of the QE has not directly funded the real economy, but paper economy, aka "Financial Markets", and in consequence "Banks", "MMF" and other market participants down the money chain, it stands to reason that the proverbial drug addict going cold turkey could hemmorhage through lending facilities indeed.
My personal belief is the Fed and ECB are either blinded by their own "speed", which they must think is too fast vs. the reality of inflation being runaway and driven in a big part initially by their QE taps running on full during what was supposed to be a slow-down. In 2020 politicians globally decided to close down whole countries on short notice and were responsible for destruction of supply chains. Central Banks already were on either close to zero funds rate regime (Fed) or a zero funds rate regime (ECB) - they then decided to not only continue but increase the free money lending into a drastic politically induced economic slowdown in the face of a pandemic (of then unknown proportions) - and they kept the policy unchanged even in the face of bubbly markets and overvaluations of real assets.
Here we are now, watching almost like the proverbial deer caught in the headlights. Will the car stop in time?
Finally a clear and concise explanation of the whole dynamics. Ty so much for clarifying it and explaining the risks and what could. This is an extremely helpful note
A side quirk of the scheme is that by swapping long-to-short duration Treasury will be reducing the face value of the Federal debt. Face value of debt is not a very relevant economic metric (debt service burden is much more important economically), but it has political significance. Total debt, debt-to-GDP are often in the news-cycle and the Administration will be able to brag about reducing them.
Then there is this thing called "debt ceiling", and with this operation the Administration will be able to expand the breathing room under it.
So I think this will have political benefits, which makes it more likely to be introduced.
One of the big factors keeping MMF in the RRP facility is that they don’t have to worry about their investments being underwater at any point as long as they put large amounts of cash in RRP over other market securities. The Fed hasn’t offered reliable guidance on where rates will really land, rightfully so since they really don’t know at this point, but without that guidance the portfolio managers see no reason to take any sort of excess risk.
The Fed needs to put the RRP rate lower than the rate markets can/will offer and allow the private markets to compete better.
I agree that this is a key benefit of the RRP - no duration means no MTM risk as rates move. It is one of several reasons why the RRP is preferable to T-bills at an equivalent yield.
The problem with your final suggestion is that you are just describing a rate cut. The Fed certainly could do this at any point, but it is the exact opposite of the "whatever it takes" attitude they are trying to convince the market they are taking.
I get what you’re driving at calling it a rate cut, but I disagree that they’re the exact same. The RRP is just a Fed created facility that they control, so they could theoretically cut only this product’s rate by something like 1 or 2 bps to make it slightly less competitive to the other money market instruments available to the Money Funds. So I’m really saying I’d like them to tweak that facility to sit lower in their described EFFR range.
I did, however, discuss this with some of my contacts today to pick their brains and they made a fair point that nothing is stopping the market from SOFR from keying off that. Repo brokers in the marketplace could adopt that lower rate too, and just force the Fed’s hand lower in a race to the bottom.
I do not have any special knowledge, but at a first glance it looks like a very risky undertaking, as short term (as described above) but also mid (inflation) and long term (higher risk of refinancing/even shorter averagematurities/higher rates down the road for the treasury. And potential gains are rather uncertain, as you said. Why then wouldn't rather FED just slow the pace of QT and/or even pause some of the measures?
The problem here comes down to the conflict of objectives. The Fed wants to slay inflation by tightening financial conditions, while the Treasury wants to loosen financial conditions (at least in the treasury market).
The Fed has to keep doing its job of tightening, while the Treasury is now trying to fight back because they have opposite objectives. This is a much more unpredictable environment than if both parties were rowing in the same direction, like they were in 2020-2021 where the Fed kept conditions loose for the Treasury to embark on endless spending.
They could do this tomorrow. They could also restart QE and cut rate tomorrows. The reason why they won't adjust the RRP is the same as why we shouldn't expect QE and rate cuts.
Do you mean inflation fighting or what? Would it lowering interest rates on just the RRP facility be inflationary, given that would mostly reshuffle the MMFs money into the treasury paper as you wrote, which is what is seeked - not to drain the banks, but pull rather money out of the RRP?
If the RRP was lowered, it would have a knock-on effect for all other rates. It would lower USTs, secured financing rates, etc. (SOFR). So if you were to cut the RRP rate by 25bps, it would likely have a similar effect as a Fed Funds Target rate cut.
The Fed could choose to do this, but it would be loosening financial conditions. Right now they are trying to tighten.
Another great writeup, thank you Bear!! Theoretically, couldn't the fed help facilitate reducing MMF reliance on the RRP by either reducing the offering of treasuries eligible for the overnight rev repo agreement through their own policy, or reducing the total pool of treasuries on their balance sheet so there simply isn't a supply there to support the current RRP demand (maybe the Treasury is the buyer)? The later would have to be an open market operation I presume?
Thanks Mr. Dustan!
Absolutely, the Fed could help if they wanted to. They could reduce the counterparty limit for RRP usage, they could lower the RRP rate, they could stop QT, etc.
Its not that they aren't capable of helping, its that they WANT to tighten. Meanwhile the Treasury does not have the same mandate or objectives. The Treasury wants stability in the treasury market and lower long term rates for debt issuance, and they don't have the duty to fight inflation. They are working with a different set of tools and objectives.
Today those two entities are in conflict.
Great write up. Thanks for making a difficult topic easier to understand. My impression after reading through twice is that, in terms of “inflation control”, the Fed and Treasury are working against each other. Seems... inflationary. Is this correct?
Other-things-equal, the goldilocks scenario above would be "inflationary", though perhaps not as much as the QE+stimulus during the pandemic, if there isn't as direct a route for turning financial liquidity into regular economy spending. (Fiscal stimulus effectively mainlined the QE monetary expansion into the economy during COVID).
But even with this distinction, you are correct, that the Fed and Treasury are in conflict. The Fed wants to tighten financial conditions (with a lagged impact on inflation), while the Treasury is looking to loosen financial conditions.
I'm not expert, but I'll just weigh in with my opinion. I'm not so sure it would be inflationary. Yes, it could cause risk assets to rally, but I'm not positive that would translate into the real economy? Just like we had 10+ years of QE induced asset price inflation with little inflation in the real economy. Furthermore, the outcome here is that short term rates get jacked up, which I can't see as being a great boon to inflation.
That's just my take and I could be completely wrong.
Its hard to just look at QE in isolation and have an accurate prediction of the immediate effect. In 08, it was a crisis prevention tool that recapitalized banks but did not lead to a huge expansion in money supply. 2011-14 QE was a growth policy, but it wasn't paired with fiscal stimulus - therefore I think it took much longer for that financial money to trickle down to the economy, though I believe it absolutely did over time. During the pandemic QE funded direct helicopter-money stimulus and therefore you saw a much more immediate effect on economic activity and inflation.
This treasury buyback scheme, if it works as intended, would probably be most similar to the QE of 2011-14, but at the same time it is fighting against headline QT by the Fed.
The best analogy I think of is that QE is like a drug - it depends on how you take it. Strict QE is like ingesting amphetamines (Adderall), while QE+Fiscal stimulus is like smoking amphetamines (meth). The transmission mechanism is much more immediate and disorderly as a result.
Thanks for the response. Your reasoning makes sense although with the closet QE I do grow concerned about a continued misallocation of capital toward paper and away from real assets focused on real production. Which, in the long term, I feel is a source of inflation as the global economy reorganizes. Frankly it doesn’t seem that anyone in the halls of the Fed or Treasury has a good grasp on the long term consequences (especially the second and third order effects) of toying with money in an attempt to manage our economy. It is all too complex and dynamic for any human brain to grasp.
I agree with these concerns, and would argue that the Treasury/Fed is aware of the long-term concerns but are much more worried about the immediate future (even if it makes the long-term consequences worse). This is the definition of short-sighted policy, but that is a common problem across many policy spheres.
It doesn't appear that anyone in any government office anywhere has an eye toward second and third order consequences. Right now it seems like the government just lurches from one disaster to the next, never being proactive, just playing cleanup by throwing crap at the wall and hoping some of it sticks. Not enough diesel? Just ban exports to Europe! So simple. What possible repercussions could there be?
I do agree though, that failing to allocate to the real economy could lead to inflation. There are so many factors that go into all of this that's it's awfully difficult to be sure of any outcome.
Thank you for the wonderful article, Mr Bear. I just became a new subscriber :)
One question please: in this buyback program, the Treasury would be buying off the market a bunch of old T-bonds at a huge discount compared to par. Some of those T-bonds are trading at 60 cents to the dollar!
Granted, the newly issued T-bills must offer a higher yield than the old T-bonds, but the Treasury would be effectively exploiting current market prices to reduce its total debt burden while it's cheap. Great move!
Thoughts?
ha that’s an interesting thought I hadn’t considered - if they are buying long dated bonds back in the open market, they will be buying below par because of the interest rate increases this year. But they would be financing it with new bill issuance at even higher rates, the net interest burden of the treasury would still increase even even if there is some sort of “gain” associated with the buyback.
That is correct: they would have to pay about 3% higher yield on the newly issued debt, but they will be buying off the old debt at a 30% or 40% discount to par. Maybe they have run their numbers and it is worth it? :)
Another fine piece. Ready for tomorrows ☺️
Coming your way soon!
Great article, thanks :)
loved the: In the end, some people end up with tokens, some with money.
The way these companies pump the coins amazes me. They use influencers, manufacture whole communities and even fashion models.
The interesting thing is that part of the people that buy into these schemes are ones you would think of as the "smart kids" - college educated, tech-savvy that have all the "right" ideas.
One person that convinced his girlfriend to invest along with himself in Terra was a cybersecurity expert... Great stuff.
Thank you sir! Though I think this comment landed on the wrong article!
I agree. I think we all will look back on this period with a bit of wonderment - like did all that stuff really happen? will be fun to explain to the next generation
Wow yes... I was reading your latest article on my mail, and clicked reply (as far as I rememmber). Sorry about that, feel free to remove it
Ha certainly wouldn't remove it! I figured it was in response to the other!
Another fantastic article. I'm learning so much about the markets and investing reading your wise words.
Too kind - I'm glad you've found them helpful. Thanks again, and please keep reading!
As someone pointed out here and as can be read in other economic write-ups there's a theory that the genie of "neverending QE" has unleashed a very "real need" by the financial "economy" for liquitidy to "never end" - the system right now is bascially showing signs of going cold turkey from a liquidity rugpull as you describe.
Inflation is not doused and is a lagging indicator - if and when the QT should be showing effects based on technical rules is probably best viewed when looking back to Bernanke and some more technocratical Fed Chairmen who seemed to follow what was later coined the "Taylor Rule".
The rule itself is arithmetic trying to balance fed funds short rates vs. CPI and other factors - here is a great chart comparing real rates to the ruleset rate - data only going to 2020 unfortunately here (FRED):
https://fredblog.stlouisfed.org/2014/04/the-taylor-rule/
And here's word from the man himself on what we are all witnessing in the current monetary policy environment, which has been on "neverending QE & money tap" since 2010.
https://www.project-syndicate.org/commentary/fed-interest-rate-policy-deviation-from-monetary-policy-rule-by-john-taylor-5-2021-08
Ben Bernanke - infamously famous for being amongst the FED Chairmen who pulled out the "full stop" in their arsenal and reacting hard and fast to inflation to try to stop it cold in its devastating tracks in the heydeys of a boom and bust cycle in the 80s was putting rates at above 18% at one point (!).
I think many here did not witness this period and how devastating the energy shock of the 70s was to fuel the later inflation curve.
HEre's some words from the man himself on what we are currently seeing in the monetery policy field - aka Biden's appointed Fed Head Jay Powell's and commitee are probably way behind the curve already:
https://www.cnbc.com/2022/05/16/bernanke-says-the-feds-slow-response-to-inflation-was-a-mistake.html
What the FED is doing now is balancing precariously in-between dousing the financial market itself, who since 2009 has become in effect an addict expecting infinite money to be shoveled, to remain with your "Furnace" comparison of an earlier essay.
Since a lot of the QE has not directly funded the real economy, but paper economy, aka "Financial Markets", and in consequence "Banks", "MMF" and other market participants down the money chain, it stands to reason that the proverbial drug addict going cold turkey could hemmorhage through lending facilities indeed.
My personal belief is the Fed and ECB are either blinded by their own "speed", which they must think is too fast vs. the reality of inflation being runaway and driven in a big part initially by their QE taps running on full during what was supposed to be a slow-down. In 2020 politicians globally decided to close down whole countries on short notice and were responsible for destruction of supply chains. Central Banks already were on either close to zero funds rate regime (Fed) or a zero funds rate regime (ECB) - they then decided to not only continue but increase the free money lending into a drastic politically induced economic slowdown in the face of a pandemic (of then unknown proportions) - and they kept the policy unchanged even in the face of bubbly markets and overvaluations of real assets.
Here we are now, watching almost like the proverbial deer caught in the headlights. Will the car stop in time?
Wow! Fantastically put, and I agree with the sentiment!
Finally a clear and concise explanation of the whole dynamics. Ty so much for clarifying it and explaining the risks and what could. This is an extremely helpful note
Thanks Ali! and as always, thank you for reading!
A side quirk of the scheme is that by swapping long-to-short duration Treasury will be reducing the face value of the Federal debt. Face value of debt is not a very relevant economic metric (debt service burden is much more important economically), but it has political significance. Total debt, debt-to-GDP are often in the news-cycle and the Administration will be able to brag about reducing them.
Then there is this thing called "debt ceiling", and with this operation the Administration will be able to expand the breathing room under it.
So I think this will have political benefits, which makes it more likely to be introduced.
One of the big factors keeping MMF in the RRP facility is that they don’t have to worry about their investments being underwater at any point as long as they put large amounts of cash in RRP over other market securities. The Fed hasn’t offered reliable guidance on where rates will really land, rightfully so since they really don’t know at this point, but without that guidance the portfolio managers see no reason to take any sort of excess risk.
The Fed needs to put the RRP rate lower than the rate markets can/will offer and allow the private markets to compete better.
I agree that this is a key benefit of the RRP - no duration means no MTM risk as rates move. It is one of several reasons why the RRP is preferable to T-bills at an equivalent yield.
The problem with your final suggestion is that you are just describing a rate cut. The Fed certainly could do this at any point, but it is the exact opposite of the "whatever it takes" attitude they are trying to convince the market they are taking.
I get what you’re driving at calling it a rate cut, but I disagree that they’re the exact same. The RRP is just a Fed created facility that they control, so they could theoretically cut only this product’s rate by something like 1 or 2 bps to make it slightly less competitive to the other money market instruments available to the Money Funds. So I’m really saying I’d like them to tweak that facility to sit lower in their described EFFR range.
I did, however, discuss this with some of my contacts today to pick their brains and they made a fair point that nothing is stopping the market from SOFR from keying off that. Repo brokers in the marketplace could adopt that lower rate too, and just force the Fed’s hand lower in a race to the bottom.
I do not have any special knowledge, but at a first glance it looks like a very risky undertaking, as short term (as described above) but also mid (inflation) and long term (higher risk of refinancing/even shorter averagematurities/higher rates down the road for the treasury. And potential gains are rather uncertain, as you said. Why then wouldn't rather FED just slow the pace of QT and/or even pause some of the measures?
This is a great question.
The problem here comes down to the conflict of objectives. The Fed wants to slay inflation by tightening financial conditions, while the Treasury wants to loosen financial conditions (at least in the treasury market).
The Fed has to keep doing its job of tightening, while the Treasury is now trying to fight back because they have opposite objectives. This is a much more unpredictable environment than if both parties were rowing in the same direction, like they were in 2020-2021 where the Fed kept conditions loose for the Treasury to embark on endless spending.
Why FED doesn't just make theRRP less attractive?
They could do this tomorrow. They could also restart QE and cut rate tomorrows. The reason why they won't adjust the RRP is the same as why we shouldn't expect QE and rate cuts.
Do you mean inflation fighting or what? Would it lowering interest rates on just the RRP facility be inflationary, given that would mostly reshuffle the MMFs money into the treasury paper as you wrote, which is what is seeked - not to drain the banks, but pull rather money out of the RRP?
If the RRP was lowered, it would have a knock-on effect for all other rates. It would lower USTs, secured financing rates, etc. (SOFR). So if you were to cut the RRP rate by 25bps, it would likely have a similar effect as a Fed Funds Target rate cut.
The Fed could choose to do this, but it would be loosening financial conditions. Right now they are trying to tighten.
So maybe in less words: yes, inflation fighting