The Fed turned dovish in part because of the rantings of Donald Trump. However, there appears to be another reason, and it has to do with the repo market. Before your eyes glaze over I will express my view clearly at the top and those who want to read on may do so.

I believe that the Fed is deathly afraid of downturns, ie recessions and bad news, because of derivatives that still exist in large numbers. There are a few telltale signs of this fear.

The Fed started out strong in 2018, raising rates to establish a more normal environment. But the market dip, what Michael Santoli called a baby bear market in early 2019 exposed the weakness of the scheme. I remember Fed members talking real tough, the hawks appeared to be in charge. But now it appears that the hawks were just allowed to talk and strut, and a dovish end was the only ultimate choice once the market weakened.

In the old days, the Fed was hawkish, and often times took down the economy and pruned wages and started the business cycle over without a whole lot of pain. Recessions were not a risk to the financial system in those days. So, this longest-running cycle is not ripe for another takedown? Apparently not. And the reason is clear, derivatives issues. They are more serious than many think.

One could almost say that keeping business cycles going is a sign of economic weakness! The Fed fears the pain of a downturn on the banks and counterparties.

Here is the bottom line. As Jeffrey Snider has said, it revolves around funding pressures, meaning collateral is insufficient and counterparties could be caught in a weakened position. Wolf Richter speaks to snapbacks at the end of this article, and they create funding pressures. So do the new CLO's, according to the BIS.

Funding pressures ultimately could put banks at risk of pain from counterparties. Clearinghouses were supposed to mitigate risk. Counterparties were to be strong in the system.

But it turns out, we are still operating where barely over 40 percent of all derivatives trade through clearinghouses! Obama lied about it in 2016 and now in 2019 we still have most derivatives trades taking place outside clearinghouses.

The newly released Table 12 from the quarterly OCC report shows that as of March 31, 2019, the vast majority (57.6 percent) of derivatives in the United States were not centrally cleared. The most dangerous type of derivative, credit derivatives, had the worst showing with only 27.7 percent being centrally cleared.

From the same article by Pam and Russ Martens:

 Another effort to mislead the public came in a highly unusual YouTube video released ... on July 10 of this year. The video pointed out numerous dodgy practices that derivative dealers are using to defraud derivative counterparties.

We found out in the Great Recession that the weakest counterparty can produce systemic risk. Why would primary dealers defraud counterparties? That is nuts.

Keeping the Business Cycle Going

How is keeping the business cycle going a sign of economic weakness? Well, in the January, 2019 addition of the ICMA pdf, the association attempts to answer questions about the repo market. On page 42, section 32, the discussion turns to haircuts and margin calls. The argument is for deeper haircuts before a crisis, limiting the necessity of margin calls during a downturn.

But a crucial understanding that arises is that liquidity tightening is the result of haircut asset decline. It is a cash liquidity issue. This may be what is happening recently in repo, because Powell said not to worry, that it is liquidity! In this case, it may be manageable. But surely there will come a time when it is not manageable. If I remember, money market liquidity combined with bad collateral resulted in the Great Recession.

In those days of the Great Recession, really bad home loans became sliced up and put into bonds that required a lot of margin calls and caused the money market to break the buck. But surely the collateral is better now, right? Well, we know that these funds are not insured. We know that there could be bad collateral backing these funds. It is not supposed to work that way. But apparently there has been a loss of confidence recently.

The Fed seems desperate to keep the bull market going and this is very different than the Fed ever acted before derivatives became so large. Yes, the Fed did liquidate the market after the housing bubble because there was so much bad collateral in the money markets.

So, why is the repo market so nervous about the quality of collateral now? Some say it had nothing to do with collateral:

The exact cause of the squeeze is a matter of some debate, but most market participants agree that two coincidental events on Monday were at least partly to blame. First, corporations had to withdraw funds from money market accounts to pay for quarterly tax bills, and on the same day the banks and investors who bought the $78 billion of U.S. Treasury notes and bonds sold by Uncle Sam last week had to settle up.

But doesn't it seem odd that with corporate taxes as low as they are that this should not have been an issue, unless the economy is slowing so greatly that money funds not normally touched were used?

The Fed has lied before. Remember that when the Fed keeps talking about a strong economy, it is an attempt to restore confidence amidst some uncertainty. Will Rogers was always amused that he was asked to restore confidence during the Great Depression of the '30's.

Snapbacks

So, other reasons for the liquidity pinch could have been the valuation of the government bonds being used as collateral. See Jeffrey P. Snider's article link at the top of this article where he mentions funding pressures.

Fear that these bonds are simply too inflated in value (as yields diminish), could have spooked the markets. Yet they are inflated in value because they are likely being hoarded. Wolf Richter contemplates snapbacks, and the current one appears to be quite severe:

But the current snapback is proportionally-speaking steeper than the others, given how low the yield was in early September when the snapback began. In percentage terms, the yield jumped by 29% in eight trading days — in other words, it’s almost a third higher than it was eight days ago.

This could be the direct reason there were problems with collateral, and of course, that problem goes way beyond the Fed lying about it only being liquidity. Creditworthy counterparties are potentially a systemic risk if they ever lack creditworthiness. Credit is essential to procuring more collateral. In that sense, it seems to be more than just a liquidity issue and Powell is lying. But most folks don't see the inside of the beast to know for sure.

The Martens goes on to quote Powell in their newest article:

…I’d say that the headline really is that while there are some concerns around nonfinancial corporate debt, really the finding is that overall financial stability vulnerabilities are moderate on balance and, in addition, I would say that the financial system is quite resilient to shocks of various kinds with high capital liquidity…

And then they respond to the Powell quote:

High capital liquidity doesn’t seem to correlate with the Fed having to pump $75 billion a day to infuse liquidity into Wall Street.

Was that just another blatant Powell lie? What about the CLO's mentioned above and other poor collateral?

They go on to decimate the Fed's transfer of trillions into the banking system. Now Dodd-Frank will not let the Fed bail out the banks so easily, which is why the rants to do away with Dodd-Frank are strengthening as we approach the end of the business cycle. The hope of the banks, of course, is that this business cycle never ends! But the Martens say this bank regulation structure in the face of so much risk to the banking system is doomed. Only time will tell.

Trump has called for negative interest rates. His plan is to make China pay to hold US treasuries. He is a lunatic, at this point, willing to decimate US companies to destroy China. The Fed has its hands full.