19-11-09 NotQE

19-11-09 NotQE

Ever since the repo market shuddered almost to a halt in mid-September, a wrong-footed Fed has been scrambling to try to ensure the seizure does not recur, with its actions leading many commentators to wail that it has re-launched QE. We explain why this is NOT the case - and also point out that such a drastic move would be largely superfluous anyway, given how the banks and money markets were already behaving.


Cantillon Consulting

November 10, 2019


  1. 2.

    Nov 9th, 2019 The first thing to realise is that,

    despite that ‘inverted pyramid’ we were all taught about in Monetary Primary School, there is no automatic mechanism by means of which the Federal Reserve can today determine the scale of money creation, much less that of bank lending or of the other forms of ‘shadow’ credit beyond that. In fact, prior to the GFC, banks’ $ trillions of liabilities stood atop a thin nanocoating of reserves that were partly so thin because even their scant number was actually redundant, given that ATM cash alone already met the exiguous contemporary requirements set in place by Chairman Greenspan. However, since the GFC unleashed QE on us (along with a host of other regulatory confusions), things have been very different. So much so that the RH graph shows we continued merrily to create money during so-called QT, only hitting the buffers in September when we dropped (sic) back to a mere 100% reserve ratio! [NB The monetary base actually EXCEEDED total M1 at the peak of reserve provision – something you definitely did NOT learn about in School!] BEFORE… …& AFTER
  2. 3.

    Nov 9th, 2019 One other salient feature of the New

    Era is that foreign banks have, for the first time, ever, held reserves to an amount equalling that of the ostensibly much larger domestic banks. Partly this was an interest rate arbitrage, given the relatively generous IOER settings, but it was also a precautionary measure – a means of adding a funding backstop to the substantial eurodollar dealings of institution severely chastened by the wholesale funding freeze of 2008. As both of those incentives have since declined in force, foreigners have been responsible for almost $7 out of every $10 of overall reserve reductions, shedding ~1/2 their peak total versus the ~1/3 loss seen at the largest 25 US banks (L25) and a near zero change at all the other domestics combined. As a matter of record, roughly half the Big Boys’ $420 billion in losses these past two years could be rationalized as showing a preference for lending to offshore branches, where the total outstanding has reached a net $230 billion, thus signalling that the carry trade may be alive and well!
  3. 4.

    Nov 9th, 2019 As can be seen from the rebased

    totals in the LH diagram, the latter part of 2018 was characterised by a notable acceleration of L25 asset growth and hence a sharp increase in reserve multiples of around 60% (from circa 130 of 2017=100 values to ~210). Though they all told the Fed as recently as August (!) that they’d be happy with 45% fewer reserves, The Bulge Bracket were then about to hit the wall as the overlapping constraints of the Liquidity Coverage Ratio regime, 2019’s new, stricter BIS limits on banking book/trading book overlaps the Global Systemically Important Bank capital framework and – it is rumoured – US bank examiner insistence that, contrary to the written rules, US Treasuries were NOT a perfect substitute for actual reserve balances all bit hard. Too many locks on the stable door meant that Dobbin was soon in danger of being caught in a hay fire.
  4. 5.

    Nov 9th, 2019 Note, too, that while all this was

    going on, banks had collectively swung from being chronically sizeable bidders for Fed funds and repo finance to large providers of them to others in a $675 billion dollar swing over the decade since the Crash. QE was evidently doing its job, you might say. However, it was just at this point of maximum generosity that, as the estimable Chris Whalen, of the Institutional Risk Analyst, relates it, one of the Biggest of the Big got caught out badly when the cash desk told the trading desk to take - er-hem - a running jump when they pitched up, looking for funding and - Kerpow!
  5. 6.

    Nov 9th, 2019 Wherein came the pressure to cause this

    eruption? Well, Primary Dealers had managed to get themselves over $900 billion short in the overnight market, possibly as they absorbed the quarterly refunding and also possibly as an offset to their swollen derivatives positions (which is here the cart and which the horse, is impossible to tell from just a glance at the raw numbers). Tax payments added to the drain, as did the incomprehensible laxity of the Fed itself in allowing the US Treasury to run up a $400-odd billion credit balance AND in continuing to accommodate $300 billion in foreign central bank repos (instead of forcing both to redistribute the cash to the wider banking system)
  6. 7.

    Nov 9th, 2019 What has been the upshot – apart

    from red faces all around at the Fed and the spawning of a host of End-of-Days hysteria in the Twittersphere? Well, the building up of a body of repos large enough to offset the US Treasury drain for one( LH graph). Even though this has expanded the Fed’s balance sheet, it is decidedly NOT an instance of QE: the Fed is trying to prevent a drain of reserves now suddenly revealed as excessive, not vastly augment their supply. The fact that all this Mack Sennett firefighting has coincided with what we might call ‘Operation Untwist’ - whereby the Fed will replace all maturing long-term Treasuries in its portfolio with a like amount of short-dated T-Bills, thus implying a near-term need to buy some $60 billion or so, each month – has also led the tin-foil hat brigade to declare that QE is here again. Once again, we must emphasize that this avowedly aims to change the composition, NOT the total of securities on the books, so *FAIL*, once more! UST General A/C
  7. 8.

    Nov 9th, 2019 Now, ironically enough, while all this regulation-driven

    confusion has been taking place – and for most of the first nine months of the year, despite the ongoing reserve decline - the US banking system has been boldly able to expand the money supply at a quickening rate, taking it up and away from the worrisomely tardy trough of QIV2018 (a trimester which was, not entirely coincidentally, a rather bad one for asset prices, you may recall). Coupled to this has been an extraordinary rekindling of the appetite for bond and - with bells on - money market fund assets, now that these actually offer a return, once more. Thus, ‘liquidity’ (a dangerously slippery concept, I grant you) has hardly been in dearth of late.
  8. 9.

    Nov 9th, 2019 Putting the two elements together, we see

    that additions to core deposits and money market funds have exceeded those of a year ago by $350 billion and $415 billion, respectively (LH graph), while the actual sums added amount to almost $110 billion a month, for an 8.8% annualized rate not rivalled since the first flood of easing was released in the wake of Lehman’s collapse (RH). The point to make here is that the Fed is NOT engaging in QE because it evidently has no need to do so – or no need, save that of ensuring that all the overlapping regulatory restrictions on banks (so much of a Mare’s Nest that neither the banks themselves nor their overseers appear to know how many reserves are needed or by whom) do not conspire to snuff out the banks’ own efforts to continue to expand the supply of money and credit. With this critical distinction in mind, the argument becomes one of whether that quickening of the pace of expansion is, or is not, a good thing to have.
  9. 10.

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