Too much money
When the Fed does QE, it means it buys debt securities — US Treasuries and agency mortgage-backed securities — from banks at par and gives them digital dollars in their accounts in exchange. reserve. So let’s look at the numbers so far since March 2020:
- $4.4 trillion in QE.
- $2.1 trillion still sits in bank reserve accounts at the Fed.
- The other big moving part here, the Treasury current account, took in $117 billion.
Since March 2021, approximately $2.1 trillion in QE has seeped into the economy. That’s about 9% of current GDP, so that’s a significant number, but let’s leave the effects of that aside for now.
The financial problem for the banks is that they have too much cash, about $1.6 trillion, and have to buy longer-dated AAA debt with it. The Fed sucked up all the supply.
I noted that QE started coming out of the banks in March 2021, at the same time it started happening:
That’s the Fed’s reverse repo facility, and you see what’s going on there – it’s grown by about $1.6 trillion since March 2020. Under reverse repo, a bank borrows Fed treasury bills in exchange for cash overnight or for a short term. This is actually a short-term tightening without having to change policy and upset the plow. During the same period the reverse repo grew by $1.6 trillion, the Fed made $1.1 trillion in QE. It was essentially a fictitious trade, with the tightening side gaining $483 billion.
So what I’m saying here is that banks have been overcapitalized since around March 2021 when they started using the reverse repo facility, and QE cash started seeping into the ‘economy. In fact, we’re ending the phase-down almost a year later than we could have. The repo facility filled the void. The banks do not need all this cash because the demand for bank loans has not been significant:
That big spike at the start of the pandemic is that everybody pulls their guns at the same time and the PPP loans go out. But as you can see, it’s down, and now there’s only $128 billion more in bank lending than pre-pandemic. Public and private lenders have stepped in with further funding as the system is teeming with capital – there is an additional $4.8 trillion in cash for households during this period.
So, instead of resorting to reverse repos every two weeks, banks would rather just buy treasury bills and mortgage-backed securities. Once the Fed stops sucking up all the supply, it will have its chance. This will not happen overnight – it will take several months towards the end of the year before reserve and repo levels normalize. By then, we’ll have up to four rate hikes, so that’s where the focus will be.
It is always difficult to say how sentiment will be affected, but in financial terms, a decrease is necessary. The biggest issue is the rate hike, and I’ve been telling members of Long View Capital since the day after Thanksgiving that we’re likely to see choppy action both intraday and daily at least during the first rate hike, which is now likely to be mid-March.
December saw a back-and-forth battle between the boring value of the Dow Jones and the more exciting growth of QQQ. But in the last week of the year, QQQ unfolded. I think we’re going to see more rout days like Tuesday where risk is punished, punctuated by big relief rallies. It’s a day trader’s dream environment, but not mine.