In Part III of my It’s All Good Until It Isn’t series on ETFs, I remind ETF investors of the pain and losses the August 2015 Flash Crash caused, make clear what really happened, and explain why it will happen again.
And, I offer advice on how to avoid the same mistakes and losses next time.
One of my favorite reads, Business Insider, threw me for a loop this week with an article titled, “‘Signs of excess are building’: 4 Wall Street giants explain why the stock market’s rally may have gone too far”.
Wall Street analysts are always worried about something, whether it’s the U.S.-China trade war, Iran’s saber-rattling, or the coronavirus spreading.
But, when big bank gurus are worried about “internals” – metrics surrounding the stocks that make up the market – maybe it’s time to worry.
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.
The single best book I’ve ever read about American history, the real history of the founding of the country, how the thirteen states were different and came together, what the Declaration of Independence meant to the diverse colonies, how the Revolutionary War shaped the country then and in the future, and what it took, how many miracles had to happen, for the new country to survive and thrive, are all revealed, in exquisite detail in Ron Chernow’s Alexander Hamilton.