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Capital Wave Forecast: Even If the Fed’s Been Duped Doesn’t Mean Stocks Will Crash Just Yet

1 | By Shah Gilani

Rumors of the Federal Reserve’s demise – in part because it was “duped” by the biggest bank in the U.S. – have been greatly exaggerated, though headlines would have us believe otherwise.

MarketWatch titled its piece back in April, “The Federal Reserve Has Lost Control of the Financial Markets.”

The Wall Street Journal asked in June, “Has the Fed Lost Its Mojo?”

Also, in June, the Mises Institute declared, “The Fed Has Lost Control.”

A few months later in September CNBC reported, “Fed loses control of its own interest rate as it cuts rates – ‘This just doesn’t look good’.”

Not only has there been no let up, fearmongering headlines are being ratcheted up.

The New York Times declared, “Fed Jumps into Market to Push Down Rates, a First Since the Financial Crisis.”

In mid-November Politico warned, “Fed’s push into funding market stirs fear of widening role.”

And a few days ago, on December 18th, The Economist, with a graphic of a fire extinguisher in the shape of a dollar sign poised over rising flames cautioned, “Despite the Fed’s efforts, the repo market risks more turbulence.”

It’s a frightening fact that repos (repurchase agreements), short-term borrowing facilities traded in the fed funds market, where banks and other systemically important financial players borrow from each other, blew up in September, right under the Fed’s none.

It’s even more frightening that the “turn” of the year is expected to put exponentially more pressure on repo rates than what the fed funds market saw in September and spiking rates could force banks, hedge funds, institutions, traders, active and passive investors to sell and have to continue selling as margin calls force asset prices lower and lower.

Once again it looks like we’re looking over the edge of an abyss at potentially huge market loses.

But the truth is The Fed hasn’t lost anything. At least not yet.

Maybe the Fed was duped by the biggest bank in the United States into restarting quantitative easing (QE). Or maybe it saw what was happening and let it happen to scare the hell out of banks and overleveraged hedge funds. No-one knows the truth there and the Fed’s never going to tell.

But, the “Fed’s lost control” narrative is fake news.

Sure, one hand came off the tiller, but they still have control of the ship. At least for now.

What’s really going on will only sharpen the horns of what investors (wrongly) believe is a long-in-the-tooth bull market…

Played or “Playa”?

The potent narrative that the Fed’s lost control spiked in September when the fed funds market, where the Fed targets interest rates banks charge each other for overnight loans, blew up.

News broke quickly that some banks had to pay as much as 9% on repos even after the Fed had lowered the fed funds rate (the rate banks pay on repos) to between 1.75% and 2%.

Why would banks have to pay so much in a market the Fed’s supposed to control with an iron fist? Had they lost control over the fed funds market and over the fed funds rate? Had the Federal Reserve lost control over how it sets interest rates across the economy?

What happened on Monday, September 16, 2019 was banks were short of cash, resulting from an unusually large auction of Treasuries the Friday before that had to paid for on Monday, combined with corporations drawing down bank balances to pay quarterly tax bills, left banks short of cash they needed by the end of the day to meet mandated reserve requirements.

As banks scrambled to borrow from each other they discovered there wasn’t the usual amount of cash available to borrow and they had to pay dearly for what was there.

Maybe the Fed Has a Partner in Crime, Or Maybe it was Played

So, how could banks not be prepared and have enough cash to meet withdrawals and reserves? How could the Fed not have known the fed funds market was prone to a cash crunch?

It turns out the biggest bank in the country, JPMorgan Chase & Co. (JPM), was doing something very few people knew about. But the Fed sure knew what it was doing.

Since the beginning of the year JPM had been cutting its loan portfolio and repositioning its balance sheet, buying longer maturity Treasury bonds, to the tune of $350 billion worth.

According to Reuters, which used public data conducting its analysis of what really happened in the fed funds market, JPM, which had been the lender-of-second-to-last resort in the fed funds market, by using the cash it had on deposit at the Federal Reserve (some of its “excess reserves”) to buy Treasuries, dramatically shrank the cash it had been lending in the repo market.

The frightening truth is it only took one bank’s drawdown of liquidity in the fed funds arena to cause the spike in repo borrowing costs.

To ameliorate the devastating liquidity, crunch the Fed had to pump tens of billions of dollars into the market by restarting quantitative easing, only this QE would not be the old QE, they announced.

And indeed, it’s not.

The new QE has the Fed buying less than one-year maturity T-bills from banks to supply them with cash, not coupon Treasuries. That’s a big difference. T-bills are not T-bonds.

What’s worrisome is the Fed buying at least $60-$75 billion of T-bills a month to flood the fed funds market with cash to ease the pain caused by JPMorgan’s huge liquidity withdrawal.

Sure, the truth is the Fed knew what JPMorgan was doing, they could see they were withdrawing excess reserves, they could see the fed funds market tightening as liquidity was being siphoned off. They knew they were going to have to restart QE, and for all intents and purposes, make it a semi-permanent policy tool by which they conduct and justify their monetary control practices.

As Zero Hedge said at the beginning of October, “It also explains why Jamie Dimon said, just days after the Sept. 16 repo shock, that the Federal Reserve did the ‘right thing’ in injecting funds to support overnight funding needs for banks.”

The Fed wasn’t duped. It was aided and abetted by JPMorgan to justify the expansion of its own balance sheet.

But there’s a catch. Buying T-bills ain’t gonna cut it.

Banks, especially JPM, have been buying coupon Treasuries and they want the Fed to buy those assets from them, like they did in the old QE days.

Why? Because buying Treasuries is a trade, a money-making trade.

If JPM gets the Fed to restart the real QE the Fed’s going to be buying JPM’s coupon bonds at higher and higher prices, handing the big bank gigantic profits on their clever trade.

Clever? Hell yeah!

The Fed was going to have to restart QE anyway (I’ll tell you the dirty truth there next week), they knew it and JPM knew it. It’s just that JPM had the balance sheet and moxie to front run the Fed and force it to intervene in the fed funds market.

JPM didn’t expect the Fed to screw up their trading strategy and buy T-bills, they want them to buy the coupon bonds they’ve been amassing all year.

And that is the short-term problem markets face at the “turn” coming up.

Year End Jitters

Coming into year-end, or the “turn” as it’s called, banks are going to find themselves short of cash they need to meet reserve requirements and they’re going to have to borrow in the fed funds market. So are hedge funds who must mark their positions at the turn and must constantly rollover the loans they get in the fed funds market. I explained all that in Friday’s WSII.

Because the Fed didn’t want to look like they’d lost control and didn’t want to look like they were restarting the old QE, they flushed up the fed funds market with T-bill repos.

Even though they’re going to add in about $500 billion into the fed funds market over then next few weeks, it may not be enough to make the turn smooth.

A lot can go wrong at the turn.

The Fed knows a lot can go wrong at the turn, that’s why it’s adding so much liquidity. And because they’re going to have to restart the old coupon buying QE in short order, whatever happens in the short run around the turn, markets are going to keep going up.

It’ll be like déjà vu all over again. The fed will expand its balance sheet and stocks will go up.

But maybe not at the turn.

We are coming into a very dangerous turn for markets, bonds and stocks. A lot can go wrong very quickly, which is why I’ve got two cheap, smart trades, call them insurance plays, to make going into year-end.

Here’s What You Need to Do

If there’s a serious blow up in the fed funds market and repo rates soar, banks and hedge funds are going to have to get their hands-on cash, fast, and the most liquid, easiest to sell assets are Treasuries.

Hard selling of Treasuries will knock their prices down, even its just for a few days, the right insurance plays could turn into a few big winners.

That’s why I’m recommending buying ProShares UltraShort 20+ year Treasury ETF (TBT). This inverse ETF goes up in price if Treasury prices fall.

The smart play is buying TBT January 17, 2020 $29 calls and paying around 10 cents for them.

If the Treasury market sells off you can make 50%, 100%, or more, depending on how hard prices drop.

Another insurance play to make money on if markets turn sour would be to buy calls on the VIX.

The VIX is trading around 12, any panic selling in the equity markets would cause the VIX to soar.

Buying some $20 strike price calls there isn’t a bad play either.

But, don’t get greedy if the turn yields panicky selling. Take your profits on your insurance plays and get ready to ride the markets higher when the Fed comes to the rescue and proves the fake headlines about its demise are greatly exaggerated.

At least for another few quarters or years…

And because this message is so important to me, my team behind Capital Wave Forecast created this new Facebook page just for you and others like you to combine forces and make the most of markets and navigate through the media spin.

I will shortly be revealing information there that will be crucial for your financial growth and education.

This is just the beginning of a series of reports that will be easily available to you there.

Things are about to get much clearer and better starting now, join me here now…

Sincerely,

Shah Gilani

One Response to Capital Wave Forecast: Even If the Fed’s Been Duped Doesn’t Mean Stocks Will Crash Just Yet

  1. ken miller says:

    The FED should get out of the interest policy business. The excess reserves market will function well without the FED providing reserves. Those who believe in the importance and effectiveness of Monetary policy are entitled to their beliefs as are children about Santa.

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