{"id":53195,"date":"2014-06-23T19:46:15","date_gmt":"2014-06-23T23:46:15","guid":{"rendered":"http:\/\/countingpips.com\/?p=53195"},"modified":"2014-06-23T19:46:15","modified_gmt":"2014-06-23T23:46:15","slug":"the-feds-stealth-tightening","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2014\/06\/the-feds-stealth-tightening\/","title":{"rendered":"The Fed\u2019s Stealth Tightening"},"content":{"rendered":"<div id=\"inves-3860960744\" class=\"inves-below-title-posts inves-entity-placement\"><div id =\"posts_date_custom\"><div align=\"left\">June 23, 2014<\/div><hr style=\"border: none; border-bottom: 3px solid black;\">\r\n<\/div><\/div><h4><span style=\"font-size: small;\">By Bud Conrad, Chief Economist, Casey Research<br \/>\n<\/span><\/h4>\n<p>As expected, the Fed tapered its purchases of mortgage-backed securities on Wednesday to $15 billion per month and its purchases of longer-term Treasury securities to $20 billion per month.<iframe loading=\"lazy\" src=\"http:\/\/trk.caseyresearch.com\/f\/?content_id=901&amp;code=PIP&amp;editorial=the-feds-stealth-tightening-1\" width=\"1\" height=\"1\" frameborder=\"0\"><\/iframe><\/p>\n<p>That means total monthly purchases, which were $85 billion last year, are now down to $35 billion. That\u2019s a significant cut.<\/p>\n<p>The Fed also cut the range of its full-year 2014 real GDP growth forecast, from 2.8% \u2013 3.0% down to 2.1% \u2013 2.3%. That was no surprise, considering that GDP in Q1 was\u00a0<em>negative\u00a0<\/em>1%, and it may have been a bit of a warning.<\/p>\n<p>Those who are familiar with my work know my no-confidence stance on Fed prognostication. But just to make my opinion clear: I think the Fed is in the business of obscuring the truth. Official inflation numbers vastly understate actual price rises:<\/p>\n<ul>\n<li>Housing in California is back to its pre-crisis peak;<\/li>\n<\/ul>\n<ul>\n<li>Stocks are at record levels;<\/li>\n<\/ul>\n<ul>\n<li>Food prices jumped 0.7% in May alone; and<\/li>\n<\/ul>\n<ul>\n<li>Anyone who drives knows that a tank of gas is far more expensive than it was a year ago.<\/li>\n<\/ul>\n<p>The Fed\u2019s claim that inflation is contained and that there is no need to raise interest rates is just a show put on for people who believe the government. If we applied a more accurate inflation rate to GDP calculations, real GDP would not be growing at all.<\/p>\n<p>My point is that the Fed and the media tell us things are better than they actually are. Meanwhile, the Fed is taking secret actions that reveal where Yellen and friends really think the economy might be headed.<\/p><div id=\"inves-1092846700\" class=\"inves-in-content inves-entity-placement\"><hr style=\"border: 1px solid #ddd;\">\r\n<div id=\"inpost_ads_header\">\r\n<p style=\"font-size:10px; float:left; color:#666;\">Free Reports:<\/p><\/div>\r\n<div id=\"inpost_ads\"> \r\n<p style=\"font-size:15px; float:left;\"><a href=\"https:\/\/goo.gl\/1ApBOV\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/investmacro.com\/wp-content\/uploads\/2018\/06\/graph_techs_PD.png\" align=\"left\" width=\"80\"  height=\"55\"\/><\/a>\r\n\t     <a href=\"https:\/\/goo.gl\/1ApBOV\"><b><u>Get Our Free Metatrader 4 Indicators<\/u><\/b><\/a> - Put Our Free MetaTrader 4 Custom Indicators on your charts when you join our Weekly Newsletter<\/p><br><br>\r\n<br>\r\n<br>\r\n<p style=\"font-size:15px; float:left;\"><a href=\"https:\/\/goo.gl\/f3RrHX\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/investmacro.com\/wp-content\/uploads\/2019\/01\/cot_pie_80.png\" align=\"left\" width=\"80\"  height=\"55\"\/><\/a>\r\n\t    <a href=\"https:\/\/goo.gl\/f3RrHX\"><b><u>Get our Weekly Commitment of Traders Reports<\/u><\/b><\/a> - See where the biggest traders (Hedge Funds and Commercial Hedgers) are positioned in the futures markets on a weekly basis.<\/p><br><br>\r\n<\/div>\r\n<hr style=\"border: 1px solid #ddd;\">\r\n<br><\/div>\n<h3><strong>The Fed\u2019s New Tool: Reverse Repo<\/strong><\/h3>\n<p>Traders have used Repurchase Agreements (&#8220;repos&#8221;) for decades. A repo is essentially a collateralized loan. A borrower sells government securities to a lender and buys them back later at an agreed-upon date and slightly higher price. The lender takes on very little risk to earn a small amount of compensation while it holds the government securities as collateral.<\/p>\n<p>Repos can last for any amount of time, but they are often ultra-short-term. Overnight repos are the most common.<\/p>\n<p>The Fed has announced that it\u2019s using \u201creverse repos\u201d as a new tool to manage monetary policy. Don\u2019t let \u201creverse\u201d confuse you: Reverse repos are just a way the Fed soaks up cash from financial institutions. The Fed is the \u201cborrower,\u201d swapping its Treasuries for banks\u2019 cash. You might call it the opposite of quantitative easing: reverse repos drain money from the financial system.<\/p>\n<p style=\"text-align: center;\"><img decoding=\"async\" style=\"width: 600px; height: 436px;\" src=\"http:\/\/d1w116sruyx1mf.cloudfront.net\/ee-assets\/channels\/article_default\/ReverseRepoatFed.png\" alt=\"\" \/><\/p>\n<p>The Fed can also use repos to add money to the system, as it did in the early stages of the 2008 Credit Crisis:<\/p>\n<p style=\"text-align: center;\"><img decoding=\"async\" style=\"width: 600px; height: 432px;\" src=\"http:\/\/d1w116sruyx1mf.cloudfront.net\/ee-assets\/channels\/article_default\/TheFedUsedRepurchaseAgreementstoAddLiquidity.png\" alt=\"\" \/><\/p>\n<p>By netting repos with reverse repos, we can see their combined effect on monetary policy over time:<\/p>\n<p style=\"text-align: center;\"><img decoding=\"async\" style=\"width: 600px; height: 435px;\" src=\"http:\/\/d1w116sruyx1mf.cloudfront.net\/ee-assets\/channels\/article_default\/ReverseReposandReposCombined.png\" alt=\"\" \/><\/p>\n<p>As you can see, the Fed is quietly using reverse repos to drain the money supply. Remember, this is on top of the taper. Net, the Fed is being less accommodative than most are aware of.<\/p>\n<h3><strong>How Repos Fit into the Fed\u2019s Balance Sheet<\/strong><\/h3>\n<p>The following chart illustrates how the Fed\u2019s liabilities (sources of funding) changed dramatically during the financial crisis.<\/p>\n<p>The Fed funded and continues to fund its quantitative easing programs with bank deposits. Here\u2019s the rundown on how that works:<\/p>\n<ol>\n<li>The Fed creates cash from thin air.<\/li>\n<\/ol>\n<ol>\n<li value=\"2\">The Fed buys Treasuries and mortgage-backed securities (MBS) from banks with that freshly minted cash.<\/li>\n<\/ol>\n<p>The Fed pays banks 0.25% interest as an incentive to keep the new cash on deposit at the Fed.<\/p>\n<p style=\"text-align: center;\"><img decoding=\"async\" style=\"width: 600px; height: 434px;\" src=\"http:\/\/d1w116sruyx1mf.cloudfront.net\/ee-assets\/channels\/article_default\/FederalReserveLiabilitiesIncludesReverseRepo.png\" alt=\"\" \/><\/p>\n<p>That huge $2.8 trillion in deposits is a risk source, because the financial institutions could withdraw those funds at any time, if they think they can generate better returns than the 0.25% interest that the Fed pays.<\/p>\n<p>Reverse repos are also a source of funding for the Fed: they provide cash for the Fed to continue purchasing Treasuries and mortgage-backed securities.<\/p>\n<p>Though reverse repos are only a small portion of the Fed\u2019s balance sheet, they are important. As the growth of the yellow \u201cdeposits\u201d has trailed off, reverse repos have picked up much of the slack.<\/p>\n<p>In effect, the Fed has sopped up $200 billion in the last nine months in \u201cstealth tightening.\u201d I use the word &#8220;stealth,&#8221; because most investors, and even most Fed watchers, aren\u2019t aware of the effects of reverse repos.<\/p>\n<p>You\u2019re probably wondering, &#8220;What\u2019s the Fed\u2019s ultimate plan here?&#8221;<\/p>\n<p>I think that the Fed is using reverse repos to build up a hidden source of funding so that it can unwind its tightening quietly, if need be. The Fed now has $200 billion in \u201cammunition\u201d that it can deploy without much (or any) fanfare, because nobody is following this closely. \u201cReverse Repos\u201d isn\u2019t the headline grabber that \u201cQuantitative Easing\u201d is.<\/p>\n<p>As a side note, notice that the Fed\u2019s capital is so small that you can barely see it. If the Fed were a bank subject to market forces, the slightest negative surprise would render it insolvent. But of course, it has a monopoly over the printing press, so it needn\u2019t worry about such things.<\/p>\n<p>One last reason the Fed might be secretly building a rainy-day fund: As my analysis in the newest issue of\u00a0<a href=\"http:\/\/www.caseyresearch.com\/go\/v8h83-2\/PIP\" target=\"_blank\"><em>The Casey Report <\/em><\/a>demonstrates, foreigners have recently stopped lending money to the US. That\u2019s a huge problem for a country that had a $111.2 billion trade deficit in the first quarter alone, and will spend\u00a0<em>half a<\/em>\u00a0<em>trillion<\/em>\u00a0more dollars than it takes in during 2014.<\/p>\n<p>As I said earlier, the Fed has been very quiet about this repo program, so we can only surmise what its true motivations are. But as the US government\u2019s lender of last resort, the Fed may be raising this source of cash so it can lend more money to the US government as foreign lending continues to dry up.<\/p>\n<p>In conclusion, the credit crisis of 2008 changed our financial system in many ways. Whether this latest repo experiment is just another Band-Aid on the money balloon or something more, it\u2019s well worth keeping an eye on.<\/p>\n<p>You can find my data-driven analysis in every single edition of\u00a0<em>The Casey Report<\/em>. Start your 90-day risk-free trial now to read the current issue plus two more, access all of the current stock picks, and peruse the archives before deciding if\u00a0<em>The Casey Report<\/em>\u00a0is for you. If it\u2019s not, no problem\u2014just call or email for a full and prompt refund.\u00a0<a href=\"http:\/\/www.caseyresearch.com\/go\/v8ht4-2\/PIP\" target=\"_blank\">Click here to start your no-risk trial subscription to\u00a0<em>The Casey Report\u00a0<\/em>straightaway.<\/a>]<\/p>\n<p>&nbsp;<\/p>\n<div id=\"xvMdV95u77zU\" style=\"clear: both;\">The article <a href=\"http:\/\/www.caseyresearch.com\/go\/v8hw5-2\/PIP\" rel=\"permalink\">The Fed\u2019s Stealth Tightening<\/a> was originally published at <a href=\"http:\/\/www.caseyresearch.com\/go\/v8hz6-2\/PIP\">caseyresearch.com<\/a>.<\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n","protected":false},"excerpt":{"rendered":"<p>By Bud Conrad, Chief Economist, Casey Research As expected, the Fed tapered its purchases of mortgage-backed securities on Wednesday to $15 billion per month and its purchases of longer-term Treasury securities to $20 billion per month. That means total monthly purchases, which were $85 billion last year, are now down to $35 billion. That\u2019s a [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-53195","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/53195","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=53195"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/53195\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=53195"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=53195"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=53195"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}