Thread by @concodanomics

The Great Financial Tightening has thrown the global monetary system into disarray, prompting large interventions by financial leaders. Markets perceived their response as a pivot, but it was just a stopgap. The real hard landing now awaits us... 1/

Ever since the great financial crisis in 2008, the system has been sculpted not by sound pre-planning of monetary policy, but by a series of experiments created during a myriad of crises. The response to the latest banking panic was just a taster of the Fed's financial alchemy...

Only four years ago in September 2019, the most relevant episode to today's fiasco hit our screens. The repo market, where parties borrow short-term cash against collateral (usually Treasuries or state-issued mortgage-backed securities) broke down in spectacular fashion...

https://twitter.com/concodanomics/status/1637769450815365120

At the start of 2019, the rate earned by lending in repo, SOFR (Secured Overnight Indexed Rate), began to rise above the interest rate banks earned on reserves: IOER. The banks piled in, quickly becoming prominent lenders in the most systemically important market globally...

Then in September, the private sector sent a large number of corporate tax payments to the govt, sucking liquidity from the banking system into the U.S. Treasury. Meanwhile, banks, now major lenders in repo, had to also absorb a large pile of Treasuries. What could go wrong?...

A lot, it seemed. Only a day later, the Fed's primary interest rate, Federal Funds, suddenly shot above its intended target range. At the same time, SOFR indicated that rates in repo had soared to over a whopping 5%. The Fed saw no choice but to act swiftly and intervene...

Facing a crisis while unsure of its actual cause, the Fed initiated yet another round of quantitative easing (QE), plus a series of overnight and term repos (jargon for loans over a fixed period of time) to push the Fed Funds rate back within its target range. They succeeded...

The Fed jamming $53 billion into the system caused a rapid fall in rates. By simply offering cash to dealers at the cheapest cost possible, the Fed stemmed the crisis. These actions became the basis for a permanent tool to prevent recurrences: the Standing Repo Facility (SRF)...

The SRF would join forces with another creation of the Fed: the Reserve Repo Facility (RRP) introduced in 2013, which has gained much attention lately. While the SRF was meant to prevent rates from rising above the Fed's target range, the RRP would defend the floor...

Markets, however, always find a way to disobey the Fed. Back in late-2015, as a Credit Suisse report illustrated, the market not only drove Treasury yields below the Fed's target range but into negative territory. The RRP's floor was more than "leaky"...

After the floor was breached numerous times, the Fed still stated it would phase out the RRP after it was "no longer needed" to control rates from "misbehaving". But markets are complex systems. Today, the RRP not only remains but holds over $2.2 trillion in repo transactions...

https://twitter.com/chainhub_io/status/1641025422799298561

Since the 2019 repo blowup, the Fed has constructed all the tools necessary to keep money markets rates firmly within its target range. Now, the potential for mishaps, and more alchemy from monetary leaders, lies elsewhere. Coincidentally, they tie in with recent events...

The cause of the present bank run hysteria was a mix of miscommunication, inexperience, and excess. A run on Silicon Valley Bank led to a run on regional banks, which only swift intervention could intercept. It was time for monetary alchemists to fire up the lab once again...

This time, they didn't disappoint, implementing the biggest stopgap since the COVID crash. As depositors at various banks were directly and indirectly bailed out by numerous agencies, the narrative turned from "Not Bailouts" to "Not QE" to "Not Easing"...

Panic even spread to Europe. Credit Suisse finally called it quits, prompting U.S. authorities to vow to provide nations, at least ones in its good books, with an unlimited supply of dollars via swap lines, stemming any contagion...

https://twitter.com/financialjuice/status/1637559757987889152

Even one of the Fed's other lesser-known tools, the FIMA (Foreign and International Monetary Authorities) repo facility, was tapped to its $60 billion limit by a nameless entity. This was likely the Swiss central bank in stealth mode or the Chinese with no access to swap lines...

https://twitter.com/FedGuy12/status/1639008118456852492

On top of all the other interventions by U.S. authorities, the Fed created one of its most intricate emergency facilities yet: the Bank Term Funding Program, known as BTFP. The longstanding theme of the Fed's "crisis responses" evolving into monetary policy looked intact...

The BTFP's purpose was, first, to revive confidence in the banking system by letting the banks and the general public know the Fed had their back. Second, it allowed banks to continue their day-to-day business (.i.e processing deposit outflows) without becoming insolvent...

Struggling entities now only need to pledge, not sell, distressed securities. The Fed accepts any collateral used in its usual open market operations, like Treasuries and MBS, but offers cash equal to the full (par) value, not market value. It's like rate hikes never happened...

Markets quickly perceived this as the Fed initiating another round of quantitative easing (QE), the Fed's mechanism for injecting the most liquidity. In reality, however, it's far from it. With QE, the Fed buys bonds and issues reserves to pay for them. This was different...

https://twitter.com/concodanomics/status/1638285013899780098

Quantitative Tightening (QT) is still underway. The Fed hasn't bought bonds outright and is (at least) trying to lower the size of the balance sheet. The sudden pop in assets reflects attempts to paper over cracks while the Fed KEEPS tightening. This is Quantitative Teasing™...

In the Quantitative Teasing era, the Fed will provide the minimal amount of liquidity and easing possible to quash anything that threatens their ability to maintain a tightening stance and avoid "pivoting" .i.e lowering rates and pausing QT. The BTFP is the ideal instrument...

In a BTFP transaction, the Fed increases the level of bank reserves in the system and sends them to the struggling bank's reserve account, while the bank sends securities to the Fed via Fedwire. But at the end of the loan, the Fed sends the security back and DESTROYS reserves...

Like with a normal repo transaction conducted in the $4 trillion daily private markets, a cash borrower pledges "eligible collateral" to receive cash from a cash lender. But at no point does the lender, or in this scenario, the Fed, fully buy the bond. This is a key difference...

As the Bank of England illustrates, central banks conducting repo transactions does boost liquidity but has minimal impact on (and provides no liquidity to) the real economy. Actual QE, the outright purchases of bonds, boosts real economic activity, though somewhat modestly...

https://twitter.com/concodanomics/status/1641051353148534786

When QE was initially devised, the idea was that the Fed buying bonds would remove duration from the market, subsequently pumping asset prices and forcing consumers to feel richer and consume. Yet, QE tended to just pump assets rather than spurring the real economy...

https://twitter.com/concodanomics/status/1641050006625873921

Today, the BTFP facility will have even less of a stimulative impact than QE. The cash the Fed provides to struggling entities will be used mostly to fund "deposit outflows", where their very own customers withdraw money to other banks or, worse, to money market funds (MMFs)...

https://twitter.com/concodanomics/status/1614675111956594691

Small banks are also likely to be deleveraging when taking on BTFP loans, while the big banks (sometimes even the recipients of the small banks' deposit outflows) will likely tighten lending. Plus, they will be paying a premium (4.79%) to watch their liquidity fall further...

In fact, the only big beneficiaries of BTFP will be entities that took advantage of arbitrage opportunities, like borrowing from the BTFP facility, buying callable bonds, profiting from the spread, and exiting the trade at the first sign of trouble, with little repercussions...

https://twitter.com/TheBondFreak/status/1636125964970127361

Despite BTFP being Quantitative Teasing, markets perceived the Fed's response as a full-blown round of QE. When the words "bailout", "liquidity", and "easing" appeared on Bloomberg, stocks rallied along with yields — which, funnily enough, tend to rise during QE...

https://twitter.com/LanceRoberts/status/1301846125813657602

Just because the Fed's actions weren't QE, however, that didn't prevent a bullish message from being sent to risk assets. After all, it's not whether you understand QE's mechanics, it's what the crowd believes to be true. And the crowd deemed another driver more influential...

The BTFD sent a signal to markets that central banks not only might grow more accommodative but suppress interest rate risk. The notion that the Fed was now willing to backstop (even some) duration was all it took to fuel a short-term meltup. Other assets joined in swiftly...

https://twitter.com/concodanomics/status/1635998075075325953

The bank bailouts were seen as a replay of the Bank of England's bond market intervention, but with less effectiveness. Those who recognized this outperformed those who bet solely on the mechanics of the Fed's actions. This wasn't a pivot, but it was stimulative regardless...

Money markets, which thrive on lower bond volatility, were once again encouraged to extend funding and credit. Lower bid and ask spreads increased liquidity for market makers and securities dealers. The effects rippled into stocks...

Low bond volatility prompted lower stock market volatility, spurring price-insensitive entities (those who don't care about price) to start buying stocks. Multiple entities were also likely caught short...

https://twitter.com/warrenbachman1/status/1641086969034817542

What's more, the huge 0.7%~ decline in Treasury yields will have caused major rebalancing from bonds into stocks. Retirement funds (like target-date funds) will have been selling bonds and buying equities. Entities like "volatility control" funds will have joined in too...

https://twitter.com/concodanomics/status/1629917607909531648

Liquidity proxies gold and bitcoin, meanwhile, have soared. The U.S. Dollar (which usually spikes during a panic) has sold off. Even the cross-currency basis, the best dollar stress signal, has barely decreased, revealing no shortage. A liquidity squeeze is currently absent...

https://twitter.com/RobinBrooksIIF/status/1639259498614226945

But that's soon about to change. Liquidity still remains on a knife edge, while the sheer power of flows has moved asset prices higher. A battle between price-insensitive buyers and bearish financial actors has been playing out in full force, but it's about to conclude...

The Great Financial Tightening, as Concoda calls it, has merely been delayed. Once the might of the U.S. consumer is unleashed, inflation will force the Fed to engineer tighter financial conditions, unless a genuine credit crunch doesn't do it for them...

https://twitter.com/concodanomics/status/1629917581334446080

The recent banking panic and the Fed's response to it reveal a pivot is now fully off the table. Monetary authorities will do everything in their power to maintain order during further tightening, without reversing course. And the most likely outcome is a hard landing.

Thanks for reading!

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