Writing a weekly column is not an easy task. The biggest challenge is coming up with relevant topics, the second biggest challenge is delivering the article to my editor by Wednesday each week. This week I thought I had it in the bag, I had targeted some time on Tuesday morning to write, and figured the Iowa Democratic caucus would provide some good material I had already said I was going to write about a few weeks ago.
Unfortunately, as of mid-day there is no material, except to comment on the electoral mess unfolding in the Hawkeye state. But that's likely been commented on enough, so let's move on.
There has been some interesting activity occurring with the Federal Reserve over the past couple of months. I’ve written about it before in regard to the REPO market, but recently I’ve been hearing the murmur the Fed is back to doing quantitative easing, and it has some investors feeling uneasy.
First, an apology, this column is bound to be a bit “geeky,” but like I said, I thought a Bernie Sanders win was going to provide me with all the content I needed to have some fun. Oh well.
Just to revisit, the REPO markets is a term that refers to the short-term exchange of cash between banks and between other financial institutions. These markets are sometimes referred to as the money markets, and REPO activity helps fund everything from lending, to payrolls, to settlement of securities trading. To put it simply, REPO markets serve as lubricant for our modern financial system, and like the oil in an engine, this market tends to be taken for granted until something goes wrong.
Well, something started to go wrong with the REPO markets in November and December of 2019. The way the problem manifested is interest rates being charged in the REPO market started soaring, indicating a type of cash liquidity crunch.
At the time, the Fed, which serves as the lender of last resort in America, had to step in to provide liquidity to this market in order to calm the stress, but what looked like isolated activity at time, has now become perceived as regular activity, leading market watchers to claim the Fed is back to doing quantitative easing, or QE.
QE is a term we haven’t discussed in a long time. The term refers to activity by the Federal Reserve of “keystroking” money into existence for the purpose of buying securities to influence certain parts of the bond market. QE is considered an aggressive form of financial intervention and was common practice by the Fed for years coming out of the 2008 financial crisis.
When we start to hear in the financial press that the Fed is back to QE, it immediately leads to speculation that it could be working to avert some sort of unseen crisis that has yet to fully emerge.
It also tends to drive traders into a frenzy, as it is widely assumed that money created through QE eventually makes its way into the financial markets, driving stock prices higher.
So, is the Fed doing QE again? Well, sort of. The central bank is pumping new money (yes, created from thin air) into the REPO markets, but the net effects of this are likely to be different than prior versions of QE that targeted parts of the longer-term bond markets.
I perceive the on-going recent short-term money creation activity as more of a backstop to the money markets, as opposed to a long-term expansion of the money supply. The banking industry has evolved since the financial crisis of 2008 and the rule changes that were borne out of it. Some of the new rules were likely to have unintended consequences; I believe the stress in the REPO markets is one of these consequences.
Unlike the stress of the 2008 crisis, caused by banks becoming too aggressive and uncreditworthy, I believe the current REPO stress is likely a result of banks becoming overly cautious in response to a tough regulatory environment. As geeky as it is, this topic is something we will need to continue paying attention to.
Opinions are solely the writer's and are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing involves risk, including loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
