The US Federal Reserve Has Lost Control: As Repo Rates Skyrocket, Rumblings in US Money Markets Reverberate Across the World!

NEGATIVE Repo Rates can happen when there is a shortage of cash or particular collateral security, like negative-yielding bonds, are put up to borrow against. Therefore, trying to borrow against a negative-yielding bond can present a crisis. The standard Repo contracts, such as the Global Master Repurchase Agreement (GMRA), have been drafted under the implicit assumption that general collateral (GC) Repo Rates would only ever be positive—Martin Armstrong

The US Federal Reserve Has Lost Control: As Repo Rates Skyrocket, Rumblings in US Money Markets Reverberate Across the World!

From Yahoo/AFP: (September 20) The New York Federal Reserve Bank said Friday it will inject billions into the US financial plumbing on a daily basis for the next three weeks in an effort to prevent a spike in short-term interest rates. The Fed will offer up to $75 billion a day in repurchase agreements -- exchanging secure assets for cash for very short periods -- through October 10, it said in a statement. In addition, it will offer three 14-day "repo" operations of at least $30 billion each. Banks have struggled in recent days to find the cash needed to meet reserve requirements which has pushed up short-term borrowing rates, prompting the New York Fed to pump billions into US money markets with repo operations over the past four days. However, in a sign a cash crunch could be easing, demand for liquidity on Friday did not significantly exceed the amount offered, as it had on two prior days. After October 10, the New York Fed will "conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined." [bold mine]

The US Federal Reserve has been forced to respond to magnified signs of instability in the money markets as evidenced by rocketing of Repo Rates that has caused considerable dislocations on the Fed’s floor monetary system.

Operating under an ample reserves framework, by establishing a “floor” or a limit at which bank lending of reserves with other counterparties, the rate of interest rate on excess reserve (IOER) supposedly influences the Fed Fund rates as “No bank would lend reserves to another bank at a rate less than the rate it could receive by simply keeping cash parked at the Fed”. (Ng and Wessel, May Brookings 2019)

And because of repurchase agreements involve the participation of nonbanks, the overnight-reverse-repurchase agreement rate (ON RRP), one of the three rates in the Fed’s monetary stance supposedly sets a floor on market repo rates. (Money and Banking June 2019)

By the way, repos or repurchase agreement (repo), as defined by the Investopedia represents “a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the party on the other end of the transaction, buying the security and agreeing to sell in the future, it is a reverse repurchase agreement.”

But theory and reality has gone asunder.

As free banking wizard George Selgin presciently observed, “If market rates don't keep step with the IOER rate, monetary policy isn't working properly. And if they don't budge when the IOER rate changes, monetary policy isn't working at all…”

Figure 1

The gap between the Effective Fed Fund (EFF) rates and IOER widened to 2009 levels. Negative spreads between the EFF and IOER emerged as far back in late March of this year. ON RRP rocketed past 2008 and 2001 recession levels last week. ON RRP has been ascendant since 2016! (see figure 1)

The consensus have dismissed and rationalized these to the “$35 billion money market outflows to fund September 15th quarterly corporate tax payments; settlements for outsized Treasury auctions; and the approaching end to the quarter (where money center banks generally reduce balance sheet leverage for financial reporting and regulatory purposes)”, however as some astute pundits have been pointing out, the scramble for short term liquidity didn’t happen overnight; it had been building through time intensifying as it ages.

Should such money market turmoil be ignored in the face of today’s uncharted environment where USD-CNY has broken the 7-threshold, sovereign bonds with negative yields which recently hit a $17 trillion as bond yields etched record low around the world, inverted yield curves gripped advanced economies, systemic leverage running at uncharted levels, global central bank in a rush to slash rates*, US financial assets at a historic 5.6x GDP, and others…?

Figure 2

*As a side note, rate cuts were announced by the US Federal Reserve (2nd for the year), Bank Indonesia (3rd time), Peoples’ Bank of China (2nd cut on loan rate), and Hong Kong Monetary Authority (2nd) this week. In contrast to the general trend, Norway’s Norges Bank increased its policy rate for the fourth time in 2019. (figure 2)

Should these just be considered coincidences? It can’t be. The perspicacious Doug Noland of the Credit Bubble Bulletin explicates: (bold added)

It is surely No Coincidence that this week’s “repo” ructions followed last week’s spike in yields and resulting deleveraging. Is it a Coincidence that the marketplace experienced a powerful “rotation” that saw the favorite stocks and sectors dramatically underperform the least favored? Is it a Coincidence that hedge fund long/short strategies have been clobbered, in what evolved into a powerful short squeeze and dislocation? Surely, it’s No Coincidence the so-called “quant quake” foresaw this week’s quake in the repo market.

Let’s expand this inquiry. Is it a Coincidence that this week’s money market upheaval followed by a few months dislocation in the Chinese money market? And is it mere Coincidence that U.S. money market instability erupted on the heels of the ECB’s decision to restart QE?

There are No Coincidences. Chinese money market issues and currency weakness were fundamental to the global yield collapse. Trade war escalation risked pushing China’s vulnerable Credit system and economy over the edge. Global central bankers responded to sinking bond yields with dovish talk and monetary stimulus, feeding the unfolding bond market dislocation. Collapsing market yields and dovish central banks stoked melt-up dynamics in stocks and sectors seen benefiting from a lower rate environment. Growth stocks were caught up in speculative melt-up dynamics, while short positions in underperforming financials and small caps were popular hedging targets. Both momentum longs and shorts became Crowded Trades

The world doesn’t operate in a vacuum. And actions have intertemporal consequences.

Figure 3

And why have primary dealers been hoarding USTs and why the accelerated stashing of these in 2019? (figure 3)

The brilliant exponent of the Eurodollar, Mr. Jeffrey P. Snider from Alhambra Partners explains: (bold mine)

How do we know which is which? Very, very easy. Every single price and yield up and down the curve says there is and has been overwhelming demand in the financial public for UST’s. So much so, people and financial entities are willing to pay premiums on them, to gain less in yield for UST’s than they would through other financial alternatives (such as the Fed’s reverse repo; why are T-bills yielding less than the RRP if there isn’t excessive demand for T-bills?)

If you are in the camp of dealers stuck with UST’s, then special factors. If you instead look at actual price evidence and apply basic common sense, dealers purposefully hoarding UST’s, unwilling to part with them apparently at any price, then you appreciate the significance of building systemic pressures which is instead more and more exposed by what are normal calendar bottlenecks no one would ever otherwise notice. The problem is therefore so much bigger than the fiscal US government deficit. Systemic monetary problem.

At the same time, DTCC’s agency fails have been climbing since June 2019. (figure 3 middle window) Collateral settlement fails, according to the DTCC, could be anchored from miscommunication, constrained technology, insufficient collateral, and counterparty insolvency.

When aggregate “fails” on a particular security balloon, it is likely a symptom of the scaling of bottlenecks and shortages of collateral settlements. And when reinforced by counterparty problems, the issue becomes systemic.

And now we proceed to the relationship between repo rates and swaps.

From Bloomberg Yahoo (September 20): Meanwhile, the costs of borrowing dollars in funding markets is still elevated. In currency swap markets, handing over yen in return for dollars for one week -- a time period which covers the crucial month end -- now costs you the equivalent of 2.4% on an annualized basis. It was just 0.2% a week ago. The same is true in cross-currency basis -- where banks and financial institutions can swap floating-rate payments in different currencies -- with the premium for the Australian dollar over its U.S. counterpart collapsing by the most in eight years during Asian trading hours on Friday. Finally, the spread between U.S. Treasuries and interest rate swaps reached a record low Wednesday. That’s an indication that traders are getting anxious about the rate at which they can finance bonds, and are starting to use swaps instead. [bold mine]

In other words, the US dollar scarcity has been spreading across the US financial markets, and subsequently, around the world.

Back to Mr. Snider: And so, ultimately, if dealers aren’t willing to sell UST’s, and that’s what all the evidence says, why would they be hoarding them like this? Not because they fear a breakdown in fed funds, the Fed being backward about everything, but because they recognize the non-trivial risks of a breakdown in repo – which is merely confirmed by the increasingly abnormal behavior in fed funds as in other more relevant and important markets like swaps.

The mainstream has advocated several fixes to the current bout of money market tremblor led by the re-imposition of LSAP or Quantitative Easing (QE) and or the Standing Repo Facility (SRF) among others.

Good luck with that.

From One Crisis to the Next: The Water Crisis, The Revenge of Economics!

The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics—Thomas Sowell, Is Reality Optional?

In this issue

From One Crisis to the Next: The Water Crisis, The Revenge of Economics!

-From One Crisis To The Next Crisis!

-Back to Back Crisis: A Religious Retribution?

-Water Crisis: The Amazing Government Failure

-The Revenge of Economics: The State Capitalism’s Rent Seeking Institutions!

-The Revenge of Economics: The Backlash from Price Controls!

-Water Crisis: The Stampede for Knee Jerk Political Nostrums

-Health Risks from Water Shortages

-Helped by BSP Easing, Possible Supply Shock From El Nino May Reaccelerate CPI

From One Crisis to the Next: The Water Crisis, The Revenge of Economics!

From One Crisis to the Next Crisis!

Haven’t you noticed that events seem to be spiraling from crisis to crisis?

         

Hasn’t the nation been gripped by a rice crisis just six or seven months ago or in the 2H of 2018?

This time, water taps of the metropolis have run dry.

Admitting to the crisis, the Finance Secretary pushed for the faster rollout and construction of the China government funded Kaliwa Dam. From the CNN, “The water shortage in the eastern part of Metro Manila calls for the faster rollout and construction of the China-funded Kaliwa Dam project as a new water source for the metropolis, Finance Secretary Carlos "Sonny" Dominguez said Wednesday. "Absolutely. In fact, have this been done before, the water crisis would be much less serious or much less of a threat," he said in a media briefing.”

So has this been a crisis because access to water became limited to 6.8 million people to a nation with over 100 million in population?

Or is this a crisis because the severe water shortage struck at the political center of the nation? 

Back to Back Crisis: A Religious Retribution?

For the Catholic faithful, could such adverse series of events signify signs of blowback?

Not content with repeated denunciations and issuing threats to its leaders, the political leadership has scaled further by assailing and denigrating the Catholic catechism. 

Though the leadership’s proclivity to cast aspersions to the Catholic Church may have been influenced partly to an unfortunate personal experience, embedded in the Socialist-Marxist ideology has been the aversion to religion.

In the Critique of Hegel's Philosophy of Right, Karl Marx wrote disparagingly of religion

Religious suffering is, at one and the same time, the expression of real suffering and a protest against real suffering. Religion is the sigh of the oppressed creature, the heart of a heartless world, and the soul of soulless conditions. It is theopium of the people.

The abolition of religion as the illusory happiness of the people is the demand for their real happiness. To call on them to give up their illusions about their condition is to call on them to give up a condition that requires illusions. The criticism of religion is, therefore, in embryo, the criticism of that vale of tears of which religion is the halo.

Could this be the first two of a possible string of plagues to befall the nation, similar to Egypt’s ten plagues in the Old Testament?The difference: the Philippine food and water crisis are man-made.

Water Crisis: The Amazing Government Failure

Like the rice/food crisis, the unfolding crisis is an embodiment of a disaster borne out of government failure.

The regulators admitted to this, from Philstar (March 14): [bold added] The Metropolitan Waterworks and Sewerage System (MWSS) admitted that the government is partly to blame for the ongoing water crisis in Metro Manila and Rizal province. MWSS chief regulator Patrick Ty said the government and water service concessionaires already forecasted water supply problem and have formulated solutions, which have been delayed. "It's our fault. It's the government because the Kaliwa Dam, Laiban Dam has been proposed since the Marcos time and due to lot of oppositions and accommodations for the IPs, from the informal settlers, from this leftist group, church group, these projects keep on getting moved," Ty told ANC's "Headstart" Thursday morning.

Another talked about the labyrinth of regulations and bureaucratic red tape.

From CNN (March 15): “Socioeconomic Planning Secretary Ernesto Pernia said the ongoing water crisis was the result of too many agencies managing the water situation. "Now we have so many agencies dealing with water. It's very conflicting.It's just not been effective, and this is why we have a crisis now," Pernia said in an interview with CNN Philippines Business Roundup.”

This observation emerged only because of the crisis?! Or the crisis exposed the fragility of such an institutional framework.

As far back as in 2007, the National Government predicted a water crisis in 2010!

From the Inquirer “Water crisis in RP seen in 2010” (January 29, 2007) [link broken, bold mine]: “The Philippines faces a severe crisis in fresh water supply in the year 2010 that may set off sectoral conflicts for the use of this most valuable resource, the Department of Environment and Natural Resources has warned.  A DENR study estimated that only 1,907 cubic meters of fresh water would be available to each person each year, making the Philippines second to the lowest among Southeast Asian countries with fresh water availability, Environment Secretary Angelo Reyes said. "The uncoordinated and uncontrolled exploitation of our country 's water resources has had a major impact on the availability of clean and safe water at present, and has already jeopardized the supply of this resource for future generations," Reyes said Friday. He cited that the study further identified that as early as now water supply constraints could be felt in nine key cities including Metro Manila, Cebu, Davao, Iloilo, Bacolod, Angeles City, Zamboanga, Baguio and Cagayan de Oro.”

Neither has this been about lack of forecasting nor political will but of fatal conceit.

As the great Austrian economist and Nobel Prize winner F.A Hayek wrote:

Whereas, in fact, specialised students, even after generations of effort, find it exceedingly difficult to explain such matters, and cannot agree on what are the causes or what will be the effects of particular events. The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Political solutions to economic problems have and will continue to backfire.

The Revenge of Economics: The State Capitalism’s Rent Seeking Institutions!

The left sees this crisis as having been caused by greed.

From the Inquirer: (March 16) Water concessionaires continue to rake in high profits amounting to billions of pesos despite being inefficient in assuring stable water supply to their consumers, a water advocacy group said on Saturday. “Corporate management of water services has been efficient in producing profits but inefficient in ensuring cheap, safe and secure water services to millions of consumers,” the group Water for the People Network (WPN) said, as quoted by the research organization Ibon Foundation. The group recalled the hype to justify water privatization during the time of former President Fidel Ramos where residents were promised “that the private profit-seeking East and West Zone concessionaires would provide cheap, safe and secure water services.” However, WPN said “the concessionaires have used their monopoly power to overcharge customers and make these excessive profits.”

Because the private sector has been inefficient, thus the call for nationalization.

From the same article:  The WPN then emphasized the need for water services to be publicly owned: “The right to water and consumer access, affordability, a0nd service quality will only be assured in the long-run if water services are publicly owned, managed and controlled.”

If the government saw the problem, yet sat on the supply issue or did nothing (for 12 years!), how and why would the nationalization of water distribution improve it?

Based on faith? The halo effect?

But the left got one thing right: the culprit: MONOPOLY power!

Privatizing profits and socializing losses has been the implicit principle guiding the political framework behind such private water concessions. These are rent-seeking firms or private firms that benefit from political privileges (in this case monopoly concessions).

The National Government (NG) subcontracted or transferred to private sector agents the operation of such utilities to free the former from financial constraints in exchange for regulated profits of the latter through price controls.

Had MWSS been the monopoly distributor, because of public subsidies, water prices would remain exceedingly low compared to demand, which would hemorrhage the agency, as well as add pressure on water supply, thus contribute to the budget deficits and public debt.

In effect, water tariff increases were justified, by the NG, through the privatization. Such tariff increases were substantiated, by regulators, on the higher costs incurred by these private sector operators.

Furthermore, by tapping the equity of these private concessionaires, the NG is freed from capital commitments.

Such private sector monopolies comprise part of State Capitalism, defined in Marxist literature as a combination of capitalism with ownership or control by the state.  And since one of the hallmarks of free markets is COMPETITION, the water crisis can’t be attributed to “market failure”.

The Revenge of Economics: The Backlash from Price Controls!

It hasn’t been true that these monopolies were free to “overcharge customers”, because the government REGULATED water prices through Rate Rebasing (RR). Profits are not signs of overcharging.

But here’s what everyone has ignored. Everyone talks about supply. Everyone also talks about demand. But hardly anyone discusses the relationship between demand and supply through prices. Manila Water sells to their products to us in pesos!

Figure 1

Water prices are set by the government with a strong implicit bias towards price ceilings. (see figure 1)

Price ceilings, as previously noted, are MAXIMUM prices SET by the government.   [See Economics 101: Price Ceiling Causes Water Shortages! March 14]

Price ceiling creates shortages. Because of political reasons, water prices are priced by the NG BELOW the market equilibrium. Excess demand or supply shortages, symptoms of such imbalances accumulate over time. El Nino simply exposed these accrued maladjustments.

Such ceilings would have been worst under a nationalized setting.

The water crisis, has thus, been an embodiment of the political-economic ramifications of price controls.

So instead of expanding, Manila and Maynilad Water used regulated prices to protect their profit margins. With prices capped, why expand?

So the left sees the evil in profits without seeing the causal mechanism behind them. Statistics is Economics.

Water Crisis: The Stampede for Knee Jerk Political Nostrums

To see the gravity of the situation, the city of Mandaluyong, where I reside, earlier stated that it may declare a state of calamity.

National Disaster Risk Reduction and Management Council (NDRRMC) said there is no need for the declaration of a state of calamity.

Yet, the water shortages have also hit Metro Cebu.

However, President Duterte ordered that the water reservoir from Angat Dam be released.

Though the water regulator, the Metropolitan Waterworks and Sewerage System (MWSS), citing lack of infrastructure, initially balked, the marching order by the President of a 150-day deadline to solve the crisis will be complied with, said authorities of the agency.  

San Miguel Corporation has offered to the NG to tap its water allotment in Bulacan.

An Executive Order (EO) will be issued by the President. From the Inquirer: (March 17) Among these provisions is the reconstitution of the National Water Resources Board (NWRB) into a body that will be responsible for policy,direction-setting, and the integration of all government efforts pertaining to water. Nograles said that the body may be placed under Office of the President’s (OP) supervision. Currently, the NWRB is under the supervision of the Department of Environment and Natural Resources. “Given the scope and breadth of water-related concerns, the supervision of OP could help ensure that all 30-plus agencies involved in water resource management are on the same page,” Nograles said. The body is also expected to craft a national water management master plan that will integrate all relevant and existing plans and roadmaps of the different agencies that play a role in IWRM. (bold mine)

So the NG intends to solve the water crisis with MORE centralization. Federalism anyone?

Other theories about the crisis had been floated. Some say this crisis has been staged.

By closing the water bypass and thereby stoking a crisis, such would expedite the rollout of the Chinese government funded Kaliwa Dam, apparently the Finance Chiefs favorite fix. Others say that the crisis will be used to justify price increases.

The Manila Water projected the normalization of water supplies in August or before summer’s end.

Unless rains will miraculously come to the rescue, the rechanneling or transferring water supplies from one area to another will be the NG’s band-aid fix. However, if El Nino persists or even worsens, then such stop gap measures will unlikely last.

My suggestion: DEREGULATE the water distribution. Allow COMPETITON to set market prices.

Health Risks from Water Shortages

The water shortage will have an impact far worse than 2018’s rice or food crisis.

Water shortages will likely increase health hazards.

The Department of Health warned of the improper of storing water, without proper cover, could bring about more cases of Dengue.

Reduced water supplies in hospitals may restrict or hamper with the medical procedure/s and caregiving services on patients. The Department of Health has limited patient watchers to one, which may have a depressing effect on patients.

Health risks increase from the consumption of unsafe drinking water.

Unsanitary toilets may force people to withhold from urinating or defecating, thereby increasing chances for ailments.

Water shortages may reduce waste treatment that may help spread disease.

Water rationing would reduce the incentives of people to clean merchandise or stores that lead to health risks.

Risks from the recycling of water on retail food establishments enhance sanitation risks.

Helped by BSP Easing, Possible Supply Shock From El Nino May Reaccelerate CPI

There are direct economic and social costs from the current water crisis.

Water shortages may also cost business reliant on water to close shop. Many have.

Water rationing may lead to increases in social conflict and theft.

The water shortage from El Nino would result in massive losses of agricultural and livestock output.

The National Government sees 33 provinces suffering from drought. That’s aside from many others province which may endure a lesser dry spell. El Nino damaged Php 464 million of rice and corn in the South. Bohol farmers and Negros Occidental rice farmers have reportedly been reeling from El Nino.

Initial estimates on losses for crop and livestock have reached P1.2 billion in nine provinces and three cities in the Visayas and Mindanao

If El Nino intensifies or prolongs, food prices can be expected to spike from the supply shock brought about by mounting losses of agriculture and livestock output.

And if the Diokno-led BSP should ease, such supply shock would be magnified! As such, the recent collapse in CPI rates may reverse, and reaccelerate upwards!

These are truly very interesting developments.

Of course, the water and the rice crisis had signified the visible events.

But the UNSEEN exists.

This declaration by the late BSP Governor led BSP at the Financial Stability Report hasn’t been publicly evident…

While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise.What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner

Figure 2

The banking system hasn’t had such magnitude of cash reserve drain (year on year in thousands of pesos) since 2010! (this chart is new). Since peaking at Php 2.8 trillion in August 2017, cash reserves have dropped by Php 444 billion in 17 months or an average of Php 26 billion per month. Cash reserves are finite.

If the repercussions from the water crisis snowball, such may aggravate the beleaguered conditions of banks.

Oh don’t worry, all the risks cited by the late BSP Governor Espenilla led Financial Stability Coordinating Council’s FSR will likely vanish in the next FSR report.

A clue from the BSP: The new BSP Governor said that he will continue to build on the progress made by the FSCC as the venue for financial market authorities to identify, monitor, manage, and mitigate the build up of systemic risk in the Philippine financial system. For his maiden meeting, BSP Governor Diokno led the assessment on the impact of the slowing global growth on the Philippines, as well as the changing economic landscape in both the US and China. “Global markets were turbulent when we closed 2018 and there are new developments at the start of 2019 that could affect financial markets,” said BSP Governor Diokno. He added that “we need to consider the possible scenarios and steer our financial system so that we can effectively manage these possibilities, and continue with our economic growth agenda.” Local market conditions were likewise reviewed, including the state of the banking industry and the corporate sector. The analysis of the Council is expected to be shared publicly with the release of the 2018 Financial Stability Report (FSR) in the second quarter of this year.

All external.

Look ma, no hands!!!!

From dislocations of crisis proportions to a rice/food crisis, now to a water crisis!

The Year of the Pig! It is still March.

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