The recent developments in the financial world have unveiled significant concerns regarding monetary policy and its implications. This week, while many were engrossed in their daily routines, Jamie Dimon, the CEO of JP Morgan Chase, attended the World Economic Forum in Davos, Switzerland, where he voiced his apprehensions about current monetary practices:
“The only thing I have trepidation about is negative interest rates, QE, and the diversion between stock prices and bond prices and yield and stuff like that…. I think it’s very hard for central banks to forever make up for bad policy elsewhere, that puts them in a trap. We’re a little bit in that trap today with rates so low around the world.”
While Dimon’s concerns are valid, he conveniently overlooked the role JP Morgan may have played in creating a challenging policy environment for the Federal Reserve. This situation has left the Fed in a precarious position, with no clear way out.
To refresh your memory, on the night of September 16/17, the overnight repurchase agreement (repo) rate skyrocketed to 10 percent, effectively freezing short-term liquidity markets. In response, the Fed intervened, conducting overnight repo operations to stabilize the rate below 2 percent.
Since that time, the Federal Reserve has engaged in these overnight operations almost daily, with amounts reaching up to $120 billion, a practice that appears to be indefinite.
For instance, on Tuesday, the Fed injected $90.8 billion into the financial system, with $58.6 billion directed towards the overnight repo and $32.2 billion towards the 14-day repo. Then, on Thursday, an additional $74.2 billion was created, with $44.15 billion going to overnight repos and $30 billion to the 14-day repos.
What Triggered the Spike?
The reasons behind the spike in the repo rate on September 16/17 remain uncertain. Was it due to a significant bank or hedge fund lacking sufficient high-quality collateral to access the repo market?
One theory suggests that JP Morgan played a crucial role. In an analysis shared by CCN, Nicholas Merten, the founder of DataDash, elaborates:
“According to Merten, JP Morgan ‘predominantly caused’ the repo market surge in September. The financial giant pulled out $130 billion from the overnight lending market. The sudden drop in reserves drove the overnight lending rate to soar to 10 percent.”
“At this point, the Fed had a choice. They could either refrain from acting, allowing interest rates to soar and stocks to plummet, or they could step in, provide liquidity, and maintain stability. We know the path they chose.”
“JP Morgan benefits in two crucial ways. First, they now have the liquidity needed to embark on a significant share buyback program, while also distributing attractive dividends to draw in more investors. This, in turn, fuels a rise in their stock price.”
“Second, by compelling the central bank to provide funding to hedge funds, they help sustain their over-leveraged positions. As long as these hedge funds continue to have access to liquidity, the extended bull market is likely to persist. In essence, the Fed—through hedge funds—is inadvertently driving up JP Morgan’s stock price.”
“Since September, JP Morgan’s stock price has surged from $107.32 to $136.84, a remarkable increase of over 27 percent, nearly double the growth of the S&P 500 during the same timeframe.”
Was this just a coincidence, or an elaborate trap? The answer remains ambiguous.
Nonetheless, the Federal Reserve finds itself in a bind… and there appears to be no straightforward escape. Here’s why:
The Impacts of Federal Reserve Policy Amid Repo Turmoil
The Fed’s recent actions to inject liquidity into financial markets, including large institutions like JP Morgan, have created a precarious assumption: that the central bank will never let a major debtor’s liquidity issues escalate into an insolvency crisis.
This assumption, without a doubt, is bound to be disproven at the most inopportune moment.
The repo market facilitates a vast array of transactions among large banks and hedge funds, collectively amounting to approximately $3 trillion in debt
Just one major bank or hedge fund failing to meet its obligations could unravel the entire network of agreements, potentially triggering a liquidity crisis with far-reaching consequences, notably rapid deflation. Thus, to mitigate against a liquidity crisis and potential deflationary spiral, the Fed feels compelled to increase the money supply. However, this needs to be done with precision—too rapid an expansion may lead to hyperinflation, but too slow a response risks a crisis. For instance, the day before, the Fed injected $74.2 billion between overnight and 14-day repos. Yet, astonishingly, net liquidity actually declined as previous operations expired, resulting in a $10 billion drop in outstanding Fed liquidity. How long before a miscalculation by the Fed leads to skyrocketing repo rates followed by a deflationary credit crisis? Most likely, the Fed will err on the side of providing excessive liquidity. However, if they overreach, consumer prices could soon spiral out of control. This encapsulates the complexities of the Federal Reserve’s policies amid the ongoing repo turmoil. Sincerely, MN Gordon Return from The Impulses of Lunar Fed Policy Under Repo Madness to Economic Prism
for Economic Prism
