Looks Like The Fed’s Been Duped – But It Hasn’t “Lost Control”

Rumors of the U.S. Federal Reserve's demise – in part because it was "duped" by the biggest bank in the United States – have been greatly exaggerated, though headlines would have us believe otherwise.

MarketWatch declared in April, "The Federal Reserve Has Lost Control of the Financial Markets."

The Wall Street Journal asked in June, "Has the Fed Lost Its Mojo?"

Not only has there been no let up, but fearmongering headlines are being ratcheted up.

Just last week, on Dec. 18, The Economist, with a graphic of a fire extinguisher in the shape of a dollar sign poised over rising flames, cautioned, "Despite the Fed's Efforts, the Repo Market Risks More Turbulence."

Repos (repurchase agreements) are short-term borrowing facilities traded in the fed funds market, where banks and other systemically important financial players borrow from each other. It is frightening that they blew up in September – right under the Fed's nose.

It's even more frightening that the turn of the year could put exponentially more pressure on repo rates, and spiking rates could force selling – with continued selling as margin calls force asset prices lower and lower.

Once again, it looks like we're looking over the edge of an abyss at potentially huge market losses.

But the truth is the Fed hasn't lost anything. At least not yet.

Maybe the Fed was duped by the biggest bank in the United States into restarting quantitative easing (QE). Or maybe it saw what was happening and let it happen to scare the hell out of banks and overleveraged hedge funds.

No one knows the truth there. The Fed's never going to tell.

But, the "Fed's lost control" narrative is fake news. Sure, one hand came off the tiller, but it still has control of the ship. At least for now.

Let's take a closer look…

Here's What Really Happened

The potent narrative that the Fed's "lost control" spiked in September. That's when the fed funds market – the market where the Fed targets interest rates that banks charge each other for overnight loans – blew up.

News broke quickly that some banks had to pay as much as 9% on repos even after the Fed had lowered the fed funds rate (the rate banks pay on repos) to between 1.75% and 2%.

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