Will Repogeddon Make Gold Rally?

One of the most important recent developments in the world of finance was the September liquidity crisis in the U.S. repo market. As a reminder, the repo market is where borrowers borrow cash from lenders against collateral in the form of safe securities such as government bonds. As we wrote in the Gold News Monitor, the U.S. overnight repo rate, which is the rate demanded to get cash in exchange for Treasuries for 24 hours, shot up from slightly above 2 percent to as high as 10 percent.

In response to this liquidity shortage, the New York Fed announced that it would conduct a $75 billion overnight repo operation every weekday until October 10, 2019, plus three 14-day repo operations on September 24, 26 and 27. The panic has been contained, while the interest rates came back to their more normal levels. Mission accomplished, right?

Not so fast! On October 4, the New York Fed said that it would extend the overnight and term repurchase operations until November 4, 2019. And on October 11, the FOMC announced that the Fed will purchase Treasury bills at least into the second quarter of next year and will conduct term and overnight repurchase agreement operations at least through January of next year. So, everything is fine, but the repurchase operations will last longer. The GDP is growing at a decent pace, while the unemployment rate is at the lowest level in 50 years, but the Fed expands its balance sheet and cuts interest rates. Something stinks here, dear Watson!

And we know what! It's the smell of bursting bubbles. It's the odour of recession. It seems that the Fed tries to keep the excessively leveraged financial market afloat and prevent its meltdown. At the same time, the U.S. central bank does not want to encourage an even more excessive risk-taking. It reminds us of the 1920s, when the Fed wanted to stimulate the real economy and prevent the stock market bubble at the same time. But it was impossible, as the money quickly flew into the asset markets. There is no eating and having one's cake too. There is no squaring the circle. You cannot support the financial market and curb its risky activities. This would not end nicely. You cannot intervene in the market without spurring some side effects. This is why the Fed's monetary policy is doomed to fail. All the Fed's tightening cycles ended badly with the sole exception of the 1994 experience. And this time will be probably no different, despite the recent dovish U-turn.

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