E Why Did The Fed Turn Dovish? Not Just Trump

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.

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Disclosure: I have no financial interest in any companies or industries mentioned. I am not an investment counselor nor am I an attorney so my views are not to be considered investment ...

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Gary Anderson 10 months ago Author's comment

Update 2: As Fed funding in repo continues, it appears that speculators and counterparties are hoarding bonds while the big banks don't want them and are hoarding cash. The Fed is attempting to make a market through liquidity injections.

Gary Anderson 1 year ago Author's comment

Update: JP Morgan says money market collateral issues will get much worse before they get better. Some collateral in the system must be crumbling. And if interest rates on treasuries go up it could be that banks continue to hoard cash rather than bonds.

Alpha Stockman 1 year ago Member's comment

Excellent!

Gary Anderson 1 year ago Author's comment

Thanjs for the encouragement! You noticed that Powell says that financial stability vulnerabilities, which really means financial instability vulnerabilities are moderate! Not minimal. Moderate. And this is before the recession.