July 07, 2022
The most exciting day of the month (to us, at least!) is almost here: the jobs report comes tomorrow morning. The release is once again the most anticipated economic read, after a few months of playing second fiddle to inflation data.
- We'll send tomorrow's Macro newsletter earlier than usual, as soon as we're done unpacking the employment report.
- But first, today we have a look at why Fed officials aren't sweating the unprecedented takeup of a key facility, and why the central bank's meeting three weeks ago feels increasingly like ancient history.
Today's newsletter, edited by Javier E. David, is 698 words, at 2½-minute read.
1 big thing: The Fed's $2T cash pileup
Something astounding is happening in the financial system's plumbing: Investors are parking a record-shattering $2 trillion worth of spare cash overnight at the Fed.
- That number blows past market-watchers' expectations, after some argued activity would peak earlier this year. It's stirred up fascination (and misinformation) among retail traders on Reddit.
Why it matters: The Fed's overnight reverse repo facility acts as a critical storm drain for excess cash, carrying effectively the same interest rate as the federal funds rate that the central bank targets. It is what enables the Fed to actually carry out its policy of raising short-term interest rates to fight inflation.
- The scale of its usage now shows the complexities in sucking up the money that flooded the economy through the Fed's pandemic-era stimulus program.
Driving the news: At the Fed's last policy meeting, officials discussed whether it could be appropriate to consider allowing participants to increase the amount of money they put into the facility each day, if "usage continued to rise," according to minutes released yesterday. It's the latest signal that officials don't see the facility's size as a problem.
- "They have no near-term interest, it seems, in trying to steer money out of it," Lou Crandall, a money market economist at Wrightson ICAP, tells Axios. "The focus for now is making sure the facility can serve as effectively as an interest rate floor as possible."
What's going on: The massive usage of the facility reflects a few moving parts.
- The Fed flooded the market with liquidity when the pandemic hit, buying trillions of dollars' worth of bonds with money that then entered the financial system. Because of that, banks now have more cash than they want.
- With banks offering low interest rates, savers have greater incentive to invest cash in money market funds, which invest in short-dated debt like Treasury bills issued by the U.S. government.
- But with the budget deficit falling, the Treasury Department is issuing less short-term debt. The outstanding stock of Treasury bills is down more than half a trillion from the end of February, Crandall says.
- "The amount of cash in money market mutual funds versus bills out in the market is totally out of whack," says Thomas Simon, an economist at Jefferies. Thus, money market funds are putting cash in the Fed's repo facility.
The bottom line: The glut of cash being parked at the Fed is reflective of policies that have already run their course, especially with quantitative tightening underway. But, "it's a representation of how much too far the Fed went in easing," says Simon.
2. The blast-from-the-past Fed minutes
The Fed was in ultra-inflation hawk mode at its mid-June policy meeting. We already knew that, but the session minutes released yesterday left little doubt, scattered as they were with references to worries that soaring prices could become entrenched, and of moving toward a "more restrictive stance" on policy.
- But since then, there have been major shifts in global markets that imply inflation is set to abate. The world looks awfully different than it did three weeks ago.
By the numbers: Treasury breakevens — the rate of future inflation implied by the gap between prices for regular and inflation-protected bonds — suggest lower prices are on the way. They implied a rate of 2.1% per year in the period between five and 10 years from now, down from 2.4% on the day of the Fed meeting.
- Commodity prices are down markedly as well, both for the near-term and futures prices for the coming years. For example, a contract for delivery of West Texas Intermediate crude oil in June 2023 was about $94 a barrel on Fed day and is below $83 now.
The question facing the Fed in the coming meetings is whether to interpret those signals from markets as a reason to let up on their aggressive rate hikes.
- But there's a reflexivity problem. That is to say, part of the reason the inflation outlook has improved in the last three weeks is because of the Fed's aggressive tack in mid-June, and that could reverse if the Fed changes its tune.
The bottom line: Expect the Fed to keep up the hawkish tone until actual inflation is coming down.