Beware The QE Trojan HorseAdvisor Perspectives
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Q3 2019 hedge fund letters, conferences and more
“What’s in a name? That which we call a rose,
By any other name would smell as sweet.”
Juliet Capulet in Romeo and Juliet by William Shakespeare
The turmoil from the mid-September crisis in the repo funding market has not subsided. Indeed, some are calling for aggressive policy actions to prevent a recurrence. Regardless of what those policies are called, they are nothing more than thinly disguised quantitative easing (QE).
The mid-September repo crisis continues to weigh on market participants. The Federal Reserve quickly addressed soaring overnight funding costs through a special repo financing facility not used since the great financial crisis (GFC). The re-introduction of repo facilities has, thus far, resolved the matter. It remains interesting that so many articles are being written about the problem, including my own.
The on-going concern stems from the fact that the world’s most powerful central bank briefly lost control over the one rate they must control.
The Fed’s measures to calm funding markets, although superficially effective, may not address bigger underlying issues. Indeed, the on-going media attention to such a banal and technical topic is indicative of deeper problems. The Fed has applied a tourniquet and gauze to a serious wound, but permanent medical attention is still desperately needed.
The Fed is in a difficult position. As I discussed in Understanding the Great Repo Fiasco, they are using temporary tools that require daily and increasingly larger efforts to assuage the problem. Taking more drastic and permanent steps requires aggressive easing of monetary policy at a time when the U.S. economy is relatively strong and stable. Such policy is not warranted and could incite the most underrated of all threats, inflationary pressures.
The Fed is hamstrung by an economy that has benefited from low interest rates and stimulative fiscal policy and is the strongest in the developed world. By all appearances, the U.S. is also running at full employment. At the same time, a hostile president is sniping at the Fed governors to ease policy dramatically. The Federal Reserve board has rarely seen as much internal dissension as recently observed. The current fundamental and political environment is challenging, to be kind.
Two main alternatives to resolve the funding issue are:
- More aggressive interest rate cuts to steepen the yield curve and relieve the banks of the negative carry in holding Treasury notes and bonds; and
- Re-initiating QE by having the Fed buy Treasury and mortgage-backed securities from primary dealers to re-liquefy the system.
The only real “permanent” solution is the second option, re-expanding the Fed balance sheet through QE. The Fed constrained since there is no fundamental justification (remember “we are data-dependent”) for such an action. Further, Powell, when asked, said they would not take monetary policy actions to address the short-term temporary spike in funding needs. Whether Powell likes it or not, not taking such an action might force the need to take that very same action, and it may come too late.
Read the full article here by Michael Lebowitz, Advisor Perspectives