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The Stock Market Has the Fed to Thank for its Latest Melt Up

1 | By Shah Gilani

Ongoing trouble in the repo market, where banks, big hedge funds and others borrow from each other, has forced the Federal Reserve to inject $400 billion into the fed funds market over the past four weeks.

That’s what’s fueling the stock market’s melt up.

Here’s how the problem in the fed funds market is driving stocks higher, why the Fed’s going to have to do even more, and what it means for future market moves.

The fed funds lending market is where borrowers use repurchase agreements, or repos, to borrow overnight or for terms of a few days to a few weeks. It has been in existential crisis mode for weeks now.

The bottom-line there is that big banks who usually lend their excess reserves in the fed funds market, to pick up interest overnight or on term loans, have been keeping more of their excess reserves parked at regional Federal Reserve banks. They’ve been doing this to collect IOER (risk-free “interest on excess reserves,” which the Fed’s been paying banks since the start of the financial crisis). Either that or they’ve been using their excess reserves to buy longer term Treasury bonds to earn more interest and speculate on interest rates falling.

That means there’s not enough money in the system to facilitate normal lending. As a result, the interest that borrowers must pay on repos has, at times, skyrocketed. And worse, sometimes the well’s dry.

To calm markets, provide necessary liquidity and not implode the financial system, the Federal Reserve’s been pumping money into the fed funds market like mad.

For example, last Tuesday the Fed offered $35 billion in 14-day term loans, because there isn’t enough money in the system to meet borrowers’ demands. There were $41.12 billion worth of bids for that money. In other words, borrowers wanted to borrow another $6.12 billion.

On the same day, January 7, 2020, the Fed executed $63.91 billion in overnight repos.

That’s $98.91 billion put into the financial system, in a day.

Repos mature regularly, whether they’re overnight loans or loans for a few days or weeks. But, there’s no new “outside’ money coming into the fed funds market to meet demand when maturing loans must be rolled over.

That’s forced the Fed to inject about $100 billion a week over the past four weeks.

All that liquidity is seen by stock market investors as proof positive that the Fed’s going to keep adding as much liquidity as needed, for as long as is needed.

A lot of that money is going to flow down to hedge funds and financial institutions who are going to park it in the stock market.

That’s fueling the stock market’s melt up.

The existential threat to the financial system because of the muck-up in the fed funds market is so dire that the Fed’s going to have to supply a more permanent solution.

Right now, the Fed’s “QE4” consists of the Fed repoing T-Bills, the shortest-term Treasury instruments.

That’s not going to cut it in the long term.

Eventually the Fed’s going to have to solve the problem by buying longer term Treasury bonds and more mortgage-backed securities.

In other words, the Fed’s going to have to turn the T-Bill repo QE4 game into a real QE game and buy longer-term Treasury bonds and securities.

That’s going to be a windfall for the big banks who bet on that happening when they pulled their excess reserves out of the fed funds market and bought longer term bonds.

Brilliant!

It’s also going to add even more fuel to the stock market.

That means we’ll see more upside for stocks.

It’s all good, until it isn’t.

Sincerely,

Shah

One Response to The Stock Market Has the Fed to Thank for its Latest Melt Up

  1. Edward Williams says:

    Good afternoon Mr. Gilani

    Please tell me which system of yours would you recommend with the current market conditions, The Money Zone or The 10X Trader. I’ve watched both presentations and they are fantastic which is a under statement. I would like to subscribe to both, but I can not at the moment. I see larger gains being made with the The10X Trader subscription service..

    Please contact me when you or you staff is available.

    Thank You In Advance

    Edward Williams

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