Author

John M. Mason

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Summary

  • The “repo” crisis that the Federal Reserve has been dealing with since early September 2019 appears to be backing off and hopefully the Fed will have time for other issues.
  • It appears as if the Fed’s actions over the last four months, keeping the repo market stable, impacted the foreign exchange market resulting in a weakening of the US dollar.
  • Hopefully, the Fed will be able to concentrate on issues other than the repo market this winter and spring with one of those things being keeping the US dollar strong.
  • Keeping the dollar strong at this time is vital to keeping the US economy growing and providing a foundation for further advances in stock prices.

It looks as if the “repo” crisis of the fall is over and the Federal Reserve can begin to focus on other policy issues.

There are still things that have to be done to allow the repo market to function move efficiently without Federal Reserve support, but the Fed should be able to handle those structural issues while focusing upon the more relevant concerns of the current economy.

The Federal Reserve has been paying a lot of attention to the “repo” issue since early September 2019.

Repurchase agreements on the Fed’s balance sheet were zero on Wednesday, September 11. On Wednesday, September 18, the Fed had $75.0 billion of repurchase agreements on its balance sheet as the support for the market began.

In the weeks between September 24 and October 30, the Fed’s policy rate of interest was relatively volatile as the repercussions from the liquidity shortages in the repo market filtered through to the Federal Funds rate.

On October 30, the Federal Reserve reduced its target range for the federal funds rate and the effective federal funds rate (the market average) dropped from 1.82 percent to center on 1.55 percent. Since the move in the policy rate and the Fed’s supply of liquidity to the repo market, the effective federal funds rate has remained right around 1.55 percent since then.

This is what the Federal Reserve said it was trying to do and it looks as it was very successful in maintaining the rate.

The only repercussion from this Federal Reserve action appeared to occur in the foreign exchange market.

Whereas the Federal Reserve had been trying to keep its short-run policy rate from declining too far and weakening the value of the US dollar, this move to provide liquidity to the repo market seemed to result in a lower value for the dollar. For example, one Euro cost $1.0905 on September 30 right about the time that the Fed really began injecting funds into the market.

By December 31, the cost of one Euro has risen to $1.1227. It appears that the need for the Fed to “work with” the repo market caused it to divert attention from the foreign exchange market, and the result was a short-run decline in the value of the dollar.

It appears as if the Fed’s adventure with the repo market is moving on, although it is not totally finished, as of yet.

As mentioned, on the September 11 balance sheet of the Fed, there were no repurchase agreements and the reserve balances in the banking system (a proxy for the excess reserves in the banking system) were at $1,458.7 billion.

The maximum amount of repurchase agreements on the Fed’s balance sheet came on January 1, 2020 when the total amount reached $255.6 billion.

Reserve balances reached the near-term high on January 15, when the balances were at $1,673.4.

Now over the whole period under discussion, that is September 11, 2019 through January 22, 2020, reserve balances have increased by $150.9 billion, as repurchase agreements are up $186.0 billion. So, it looks as if the Fed pretty well underwrote the increase in the excess reserves in the banking system by means of the use of repurchase agreements.

But, since January 1, 2020, repurchase agreements are down by almost $70.0 billion, and have dropped every week this year.

Is the “repo” problem over?

Well, the Federal Reserve has not overseen the restructuring of the repo market yet, so the mechanics that were causing the difficulties have not been eliminated. There is still work to be done here.

But, for the time being, hopefully, the liquidity problems that occurred in the fall will not arise again, at least until April, and the Fed can turn its operating focus to other factors, like the foreign exchange market.

One other point needs to be made at this time. The Federal Reserve has been restructuring its securities portfolio, buying US Treasury securities and letting mortgage-backed securities run off.

Since September 11, 2019, $91.0 billion in mortgage-backed securities have matured off the Federal Reserve’s balance sheet.

During this same time period, the Fed has added US Treasury securities in the amount of $280.0 billion.

You might ask why I have not added these actions into the discussion on the “repo” issue?

Well, I believe that the Fed was taking care of other issues that had little or nothing to do with the “repo” issue.

Thus, the Fed bought, net, $189.0 billion in securities and these purchases add bank reserves to the banking system.

During this time period, the public drew almost $30.0 billion in cash out of the banking system and the US Treasury Department took $228.0 billion out of the banking system and deposited the funds in the Treasury’s General Account at the Federal Reserve, the account it writes checks on.

This meant $258.0 billion was being drawn out of the banking system. To cover this drainage, there was the Fed’s purchase of US Treasury securities of $!89.0 billion with the rest of the drainage covered by the excess repurchase agreements mentioned above.

So, the Fed handled the “repo” crisis smoothly after a kind of bumpy start, and it also handled the seasonal swing in cash outflows from the banks and the movement of US Treasury deposits into the Fed without any major disruptions. Good job!

But, now we get back to the future. Hopefully, the “repo” situation is over and the market structure of the repo market will be taken care of. My next concern, as I mentioned above, is the foreign exchange market.

The US dollar hit a near-term low around the end of December with the cost of one Euro rising to $1.1227. But, there have been a couple of events that have allowed the value of the dollar to edge up.

First, as mentioned above, the “repo” situation seemed to ease after the first of the year and the value of the dollar did show a little pickup as this occurred.

The other factor is the Chinese virus situation that has caused “risk averse” funds to move to “safe haven” markets like the United States and this has helped the dollar to rise in value.

Hopefully, the Fed will be able to act in a way to keep the value of the dollar up and to see that it stays up. This, to me, will be the best thing for the US economy and for the stock market.

I believe that investors are also thinking this way.

Author: John M. Mason

Source: Seeking Alpha: Federal Reserve Watch: The ‘Repo’ Crisis Is Over

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