It has been reported recently that the U.S. Federal Reserve is pumping billions of dollars into money markets and that we apparently have nothing to worry about?
Bank liquidity
Do you remember twelve years ago when the first financial crisis cracks started to emerge? One of them being a shortage of cash in the money markets (liquidity), where banks and financial institutions lend to each other.
Credit crunch
Do you also remember phrases in the news at the time leading up to the crisis like, ‘credit crunch’ and ‘subprime lending’? And then do you remember central banks eventually intervening? The European Central Bank was the first to intervene after concerns surfaced about a particular risky fund. This was then quickly followed by the U.S. Federal Reserve intervention and then by a similar operation from the Bank of England.
Been here before?
I am beginning to wonder if we have recently witnessed something similar happen again? Since mid September we have seen the Fed pump hundreds of billions of dollars into the U.S. money markets again – on a daily basis and we have been given the simple explanation that we have nothing to worry about and nothing is ‘seriously’ wrong. Oh really!
Mis-selling?
Much the same was said at the time of the credit crunch before the full horror of mis-selling of U.S. mortgages and of their conversion to highly dodgy high yielding securities was discovered. Go see the Big Short!
Central bank intervention
After the crash tough capital rules were imposed on banks, and a system was devised to deal with bad banks and to ring fence and separate retail banking from investment banking – central bank intervention (or interference) had begun in earnest and so far to-date, central banks are still heavily involved.
It could be argued that ‘things’ are still far from fixed!
High debt?
And equally worrying is that none of this has eased the appetite for risky debt. Corporate borrowing stands at around 150% of the U.S.’s total output. Business loans have soared, and at the end of 2018 reached some at $1 trillion. Much of this highly leveraged debt is of a likely ‘junk’ quality and perversely attractive to investors because of high yields – ring any bells?
Debt from the corporate-lending has been wrapped up and ‘shipped’ or ‘spread’ out to investment and pension funds. Japan and Korea have been big buyers of these securities and have hedged the risk. In a crisis, it is not just the underlying security which could go wrong, but the insurance wrapper too. Alarm bells ringing again yet?
Seen this before?
Aren’t there similarities in this very familiar pattern. Is history about to repeat itself? What if debt becomes dangerously out of scale in relation to the underlying means of payment again? What if history is about to repeat itself? This may or may not be the case – but I am concerned of the distinctive similarities now playing out in the markets.
I may be mis-reading the current U.S. money repo markets – but could it just be that the extra Fed operations are necessary to avoid a major financial failure happening again?
Oh, and I almost forgot to mention the very recent U.S. 10 and 2 year bond ‘yield curve inversions’. From an analyst’s point of view this is seen as a warning signal and a prelude to recession (potentially). It’s a VERY BIG red flag!
Markets reacted badly to the first yield curve inversion – and now it appears to be almost forgotten and ignored? Strange times!
It’s been right before! Be careful!
More to follow on repo…
Ongoing post…