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CorkRockingham
Member since Jun 2017
177 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
So specifically what kind of funds should I park some of my money in. I don’t quite understand why, if we believe that the market is close to a top and that it will soon retreat, and that inflation will not be present, Why the value of our currency would increase.

Well take that back, I get deflation, your purchasing power grows.


Ok, two scenarios, could you give me some specific finds.

1. Market retreats, inflation goes up.
2. Market retreats, inflation nonexistent.


wutangfinancial
LSU Fan
Dallas, TX
Member since Sep 2015
4798 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
quote:

1. Market retreats, inflation goes up.



This won't happen but TIPS

quote:

2. Market retreats, inflation nonexistent.



This should happen. Treasuries. There was a 20 year trading at 98 par yesterday that still has 20ish% upside when rates hit the lower bound.


CorkRockingham
Member since Jun 2017
177 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Is buying a etf of us treasury bonds a smart place to park capital? Does it function the same way as holding the actual bond?


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RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Interesting article claiming there are “only” $2.948T left in Treasury bonds and notes that the Fed could buy in the form of additional QE, unless the Treasury issues more.

While that’s still a large number (about 43% of Fed’s current balance sheet), the author cites a Fed economist saying another $3.5T of purchases are needed to offset the Fed’s self-imposed limitation of not allowing rates to cross the zero lower bound.

In other words, absent additional Treasury issuances, the Fed may have to focus more on MBS or other assets in lieu of allowing rates to cross the ZLB. Or they could relax their restriction that the ZLB not be breached, in which case, according to Fed logic, they wouldn’t have to buy as many Treasuries.

This, the author claims, is why the Fed has been jawboning for more fiscal stimulus, so they have more to purchase via their beloved QE programs.

I haven’t independently confirmed all the author’s claims, but they appear well researched and backed by links to official data.

Now, here’s where things really get interesting. Recall that the Fed can’t buy Treasuries directly. They have to buy it from the commercial banks who buy it from the Treasury via the primary dealers. In turn, the commercial banks, in order to buy more Treasuries, have to have more in reserves. And where do they get their reserves? Well, lately, from the Fed. So, it appears, we have a classic chicken-egg dilemma on our hands.

The rest of the article after that goes in a different direction that I didn’t find compelling, but the above summary I provided is what I thought was interesting. Of course, the Fed will likely get more Treasuries to buy once the next round of stimulus materializes, but it’s a good thought exercise to consider the limitations of their buying power in the meantime.

LINK



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RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
WTF, if you get around to reading Dr. Hunt’s 3Q letter, this is a good, 30-min video from Van Metre to go along with it:

LINK


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Another great read:

What’s behind the Fed’s project to send free money to people directly?

Looks like the Fed is seriously considering Dr. Hunt’s biggest fear. What’s most striking to me about this is that one reason the Fed says they like it is that it would almost definitely drive up inflation, which would in turn drive up the yield curve.

So ... they won’t hike rates because that would pop the asset bubbles which mostly benefit the rich, but they’re fine with considering a policy to intentionally create inflation which will disproportionately hurt the lower classes. Hey, at least they got a handout before their purchasing power went to shit, right?

But the Fed also understands that forcing inflation would drive up yields, which gets you to the same result as just hiking rates directly. So why not just hike rates directly? Are they hoping the direct payments would create enough consumption to more than offset the negative impacts of higher rates? Or do they just not want to be the direct cause of rates going up which could pop asset bubbles?


wutangfinancial
LSU Fan
Dallas, TX
Member since Sep 2015
4798 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
quote:

Looks like the Fed is seriously considering Dr. Hunt’s biggest fear


They have been talking about the digital currency for quite a while now. I was listening to a guy on Gammon's podcast and apparently the IMF is pushing this internally and the Davo's crowd is all in for the DTC Fed bank account. They are going to blow up the bond market if they go through with it. And like you're saying

quote:

Or do they just not want to be the direct cause of rates going up which could pop asset bubbles?


I think this is the main driver of monetary policy since 9/11. Everybody knows what's going on and how to fix it but they resort to can kicking out of fear to be "the one" that blows up the monetary system.

quote:

Are they hoping the direct payments would create enough consumption to more than offset the negative impacts of higher rates?


They think it will but I don't even know if that true. Like the stimulus payments, most people used their money to payoff debt and the savings rate exploded. They will have to go full authoritarian and force them to spend, maybe by having the dollars evaporate from your account after a certain amount of time. The phychology of the economy is entirely different than February.


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
I started the Van Metre podcast today from his recent appearance on Real Vision and his theory is that the Fed knows it can’t create inflation, but is just trying to scare people into spending more instead of saving. Think about how brutally dishonest that is. I’m not a Fed hater, but their credibility is taking a massive hit here recently, in my opinion. By delaying the inevitable, they’re only going to make the inevitable much much worse. Just hoping the negative correlation between stocks and the USD holds.
This post was edited on 10/19 at 8:45 pm


wutangfinancial
LSU Fan
Dallas, TX
Member since Sep 2015
4798 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
If Biden wins and they take the Senate. It will become impossible to generate inflation without law changes. I'm going through a 52 page report on some of the regulatory changes on top of the tax increases and it's mind blowing anybody would think it's realistic to implement.

Just a fun little example that made me lol

quote:

These plans are ambitious. Unless people drive a lot less, the electrification of all, or even
most, passenger vehicles would increase the per capita demand for electric power by about
25 percent at the same time that more than 70 percent of the baseline supply (i.e., electricity
generated from fossil fuels) would be taken off line and another 11 percent (nuclear) would
not expand. To put just the 25 percent in perspective: that is the amount of the cumulative
increase in electricity generation per person since 1979, which is a period when nuclear
and natural gas generation tripled. Taking the scale of the transformation into account,
even before seeing the details, it should be no surprise that such ambitious policies will be
expensive, to the point of dominating the economic costs of Vice President Biden’s overall
agenda.


Much like the Fed I think this is just porn for voters and no serious Dem Pol would vote for this stuff but stagflation is coming at some point.


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
That is interesting, mostly because there's no way our grid could handle it. Ground zero of the "rapidly decarbonize + flood the market with renewables" right now is Australia, who has the distinction of having some of the highest electricity prices in the world, which have increased by a few hundred percent since they went green. Here's what they've done:

(1) Holy smokes, we have a ton of LNG and we don't really need it b/c we have coal; let's build out our LNG export infrastructure and ship all our gas to Asia.

(2) Wait a minute ... coal is bad. Let's start shutting down our coal plants.

(3) Ah, shit, our baseload power is no longer secure and we can't build gas plants because we're shipping all our gas to Asia. Let's overbuild renewables, subsidize them and give them first priority in the dispatch stack.

(4) Sunuvabitch, now that coal plants don't have certainty into baseload supply anymore, private operators are unilaterally shutting down EVEN MORE coal plants. We didn't intend for THAT much coal to shut down.

(5) Crikey! We solved our capacity problem, but now we're facing horrible energy shortages because renewables = intermittent.

(6) Prices skyrocket. Crap. We need more transmission capacity to pipe around this unpredictable renewable energy to where it's most needed. Reliability improves, but prices go even higher to finance the transmission upgrades.

(7) Now we need to come up with a way to incentivize our struggling coal plants to stay online instead of shut down. We need a capacity market that pays them to stay online for emergency purposes even if they hardly ever clear our distorted market.

It's a fascinating market and a must-study for anyone seriously contemplating flooding the market with RE whilst shuttering FF. As I said in another thread, RE is a complement to FF, not a substitute. At least not yet (or likely anytime soon).

This post was edited on 10/19 at 9:11 pm


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Had been meaning to read Irving Fisher's The Debt-Deflation Theory of Great Depressions for a while. Finally got around to it. The paper is written as a "creed" containing 49 "articles" around what causes depressions. It's not the easiest read, but the key takeaway is that:

quote:

18. In particular, as explanations of the so-called business cycle, or cycles, when these are really serious, I doubt the adequacy of overproduction, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence, over-investment, over-saving, over-spending, and the discrepancy between saving and investment.

19. I venture the opinion, subject to correction on submission of future evidence, that, in the great booms and depressions, each of the above-named factors has played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two. In short, the big bad actors are debt disturbances and price-level disturbances.


It's hard to disagree with Mr. Fisher:



wutangfinancial
LSU Fan
Dallas, TX
Member since Sep 2015
4798 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Guess when government debt as a % of GDP bottomed? Almost the exact % Lacy Hunt claims the MRP of new issues debt begins to deteriorate at high and increasing rates. Unbelievable.


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Damn, you're exactly right. We didn't delever after the Great Recession, which is when Debt-to-GDP breached 65% and also when we entered the "new normal" of sub-3% annual real GDP growth. And then in 2010/2011, we breached the 90% mark, which is when Dr. Hunt says things really become acute. Currently at 136%

This tells me all of the recent economic "strength" has been obfuscated by the one-time benefits of tax and regulation cuts. We're likely in a 2% real GDP world for the foreseeable future.

This post was edited on 10/20 at 1:26 pm


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Got through this Steven Van Metre interview on Real Vision this morning. For anyone who wants to understand how QE impacts liquidity, this is a must listen. It's also available on Spotify. The conversation beginning around the 20 minute mark is very enlightening in terms of clarifying that QE doesn't create liquidity; it only creates the potential for liquidity. That potential is only realized if commercial banks use their newly credited reserves to lend against. Absent that, QE removes liquidity and is thus deflationary:

LINK


CorkRockingham
Member since Jun 2017
177 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
I listened to this podcast and what Steven said doesn’t make any sense to me. He said that quantitative easing decreases liquidity and that the banks can not physically touch the money in their federal reserve accounts.

Could you clarify that for me? I believe that once the new money is added to their federal reserve account that they can access it and lend with it up to their federal fractional reserve limit.


wutangfinancial
LSU Fan
Dallas, TX
Member since Sep 2015
4798 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
quote:

Could you clarify that for me? I believe that once the new money is added to their federal reserve account that they can access it and lend with it up to their federal fractional reserve limit.



They can but they aren't


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RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
My understanding is that it all boils down to the fact that the Fed cannot create legal tender. When a bank sells a Treasury to the Fed, they are selling a highly liquid asset that can be converted into legal tender in exchange for a highly illiquid asset that cannot be readily converted into legal tender (reserve credit), barring some other event. The banks do have the ability to lend against the reserve credits they receive, but that’s not a forgone conclusion. They may not do so if (a) they are reluctant to lend or (b) borrowers are unwilling to borrow. If the banks do lend against their reserves, then at that point liquidity is increasing and this could be inflationary. But when (a) or (b) prevents the reserves from being lent against, the net effect of QE is a deflationary reduction in liquidity in the financial system.

The question comes down to whether you think (a) or (b) will occur. What we’ve seen recently is that banks are tightening lending standards and many consumers are saving and deleveraging. For instance:

quote:

The Federal Reserve Bank of New York’s Center for Microeconomic Data today issued its Quarterly Report on Household Debt and Credit, which shows that total household debt decreased by $34 billion (0.2%) to $14.27 trillion in second quarter of 2020. This marks the first decline since the second quarter of 2014 and is the largest decline since the second quarter of 2013.


LINK

What I don’t completely understand is the WHY behind a bank trading a Treasury for a reserve credit they can’t touch. I presume it’s to shore up their reserve requirements (which includes cash and any credit balances in its account at the Fed) and to maintain their trading relationship with the Fed, but I’m sure there are other reasons. Maybe the Fed buys the Treasuries at a premium or this allows the banks to generate fee income.
This post was edited on 10/22 at 9:20 am


CorkRockingham
Member since Jun 2017
177 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Wait you are not making sense to me.

If the banks were not able to access (physically) touch and lend the money in their federal reserve accounts then there would be no new creation of money.

I believe what Wutang said is correct that they can but they aren’t.


Please clarify this because this is a crucial point whether or not the banks can physically access the new capital from quantitative easing and lend it out to borrowers.


RedStickBR
LSU Fan
Member since Sep 2009
13982 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
So, as I understand it, we're talking about two different but related things:

1. The reserve credits the Fed creates when they buy Treasuries from commercial banks. This is what the commercial banks can't touch. They can lend against it, but they can't actually convert these credits into dollars.

2. The additional lending that the banks do against the reserve credits. This is when new money is created. But, and this may have been WTF's point, just because they can lend against these reserve credits (which creates liquidity and is inflationary), they have not been (which has reduced liquidity and is deflationary since, on net, assets that can be converted into legal tender have left the financial system only to be replaced by assets that cannot be converted into legal tender).



Thus, short of creating liquidity, QE when you're stuck in a liquidity trap is simply meant to buy rates down to spark consumption. That hasn't worked, so the Fed has attempted to scare people into consuming by talking up inflation. The verdict is still out as to whether or not that will work.

ETA: To address your comments directly, and per my understanding of SVM:

quote:

If the banks were not able to access (physically) touch and lend the money in their federal reserve accounts then there would be no new creation of money.


This is the aha moment SVM keeps screaming from the mountaintops. Everyone thinks QE creates new money, but it doesn't. It only creates the potential for new money (see my recent post about apples vs. apple seeds for more).

quote:

Please clarify this because this is a crucial point whether or not the banks can physically access the new capital from quantitative easing and lend it out to borrowers.


My understanding is: No, they cannot.
This post was edited on 10/22 at 12:01 pm


CorkRockingham
Member since Jun 2017
177 posts

re: Discussion of Fed Liquidity’s Impact on Equity Markets
Thank you for your thoughtful response.

Wutang do you agree with this?

Because if what you are saying is true redstick then how does new money come into creation. If the banks can only lend against their federal reserve credits then they can provide digital loans. But really what you are saying is that the money the bank currently has on hand can be depleted because their federal reserve required holdings have been reduced or replenished by the FED.

When I read that out loud it makes me think I still have it wrong. Because if that is the case then the banks would actually reduce the amount of money they have on hand and a bank run (if one were to happen) would mean that they have less money to actually give out before closing down.

Do you get what I’m saying?


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