Powell has a bit to stew on over the next few days before he takes the stand on Wednesday to announce another .75% rate hike …
Well, at least .75%. That is a given, and the market has further priced in a 1-in-5 chance of a full-point hike.
It’s important to remember this will be the last Fed meeting until Nov. 2, so what Powell has to say during the Q&A will have a lasting impact.
Certainly FedEx (Ticker: FDX), the global transportation bellwether, adds some drama to this rate hike after shocking the markets with a massive downgrade in earnings – and warnings of a “worldwide recession” – last week.
The Fed has to be considering the fact that an earnings recession is clearly heading our way …
Now, after next week, the top of the Fed funds rate range will be 3.25%, a full .75% over the peak in rates prior to the repo market breaking in 2019 and the Fed having to shift back to QE.
Today, I’ll share details on why the Fed is continuing – and when we can expect something to break and see the Fed being forced to go back to QE.
The Fed Purposely Built a Cushion
The Fed did think ahead before entering the tightening cycle by introducing the Reverse Repo facility (RRP).
RRP is simply a facility where 100 counterparties are able to deposit their excess cash directly into the Fed account and earn risk free returns …
This rate grows as the Fed continues its rate hiking cycle. Currently, the rate is 2.30% and it will move up another .75% after the rate hike on Wednesday.
Notice how the facility has grown since inception ..
Federal Reserve Reverse Repo Facility amount outstanding
Now that $2 trillion deposited at the Fed is money market funds that are happy to keep it there until another risk-free investment comes along that pays a higher rate …
Well, that day is coming soon because the QT process in which the Fed sells the US Treasuries into the market is in a period when there is not very much demand for them …
When you’re increasing the supply of bonds into a market that isn’t very liquid, you’re going to get volatility. So, because not all the counterparties are money funds, roughly 50% or $1 trillion is rolled into the new best that is sold into the market.
To monitor the outstanding balance go to Fed Reverse Repo where you can see the balances and the rates on a daily basis.
We should see the funds drained from RRP within six months.
When that happens, the cushion for the Fed will be gone. That is when the stuff hits the fan and a chain of events causes a financial crisis.
It goes like this …
– Word spreads to the lenders that cash in the system is drying up
– Then certain counterparties are forced to go directly to the fed for emergency funds
– Now everyone is fearful of lending to an insolvent borrower so cash is pulled from the repo market
Here is what that looks like, which is exactly what happened in 2019 ….
Before it was all over the repo rate actually spiked as high as 10% …
This was on Jay Powell’s watch and it wasn’t pretty much a mad scramble to find a willing lender to meet margin calls and balance payments at all financial institutions
Powell pulled out his bazooka and blasted $500 billion into the repo market, which I am sure he will do again except it may be double or triple that today …
The repo market is often called the plumbing that lubricates the gears of finance. That is still the case today and although Powell has a cushion that could disappear very quickly …
My prediction is the Fed pauses the interest rate hikes before Halloween and they pivot back to QE before Memorial Day 2023.
Bring It Home
A contact of mine was telling me how the administration is using the Fed’s monetary policy to strengthen the dollar in an attempt to use it to take the Russian economy down …
Nothing would surprise me but everything we have to combat Putin has backfired!
Let’s hope this turns out differently.
The great news is … All these cross currents of geopolitical risk are awesome because they keep Vol high and that provides tremendous trading opportunities.
We have a three-man team, including myself – who has spent 25-years trading for global banks – Frank Gregory, Option Pit’s political expert and Andrew Giovinazzi, who has an impeccable reputation as one of the best option traders and risk managers anywhere.
And we’re all working for you!
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Live and Trade With Passion My Friend,
Griff