Understanding The Fed – Is the Repo Market Broken? (w/ Raoul Pal)

Real Vision CEO, Raoul Pal, examines via Skype the recent turmoil with an international cadre of outspoken experts: monetary economist George Selgin, George Goncalves of The Bond Strategist, Scott Skyrm, executive vice president at Curvature Securities, and Dr. Z. Barton Wang of Barton Research. Join Raoul on this voyage of discovery as he discusses repo and more with some of the sharpest minds in finance. Filmed on January 31, 2020, in Grand Cayman.


< 8 min: I tend to agree with the Fed that the current repo operation is not QE, but that having a standing repo facility handles high demand (like at the end of the month)

There are multiple factors that combine to increase liquidity demand.

12 min: The balance sheet is never going to go down.

13:30 min: The Fed and Treasury don’t appear to be talking.  One theory is that Mnuchin is trying to force the Fed’s hand

17:26 If we have a recession, we will see genuine QE that no one can deny.

I worry that they will resort to QE even if there isn’t a recession.

  • corridor vs floor system

~19:30 There is a lot of leverage that keeps asset prices high and liquidity is necessary to support this.

I’ll all for the Fed providing liquidity, but there should be a penalty rate

20:10: I agree that QE will happen and it will arrive quickly.

The next QE will be done in such a technical way as to “bore” the public.

33 min: The Equity Markets believe they are doing a version of QE.

(QE) is like a calibration thing.

They are going to have to steepen the curve.

44 min: Most of the Hedge Funds that want cash want it first thing in the morning, but other players come in later (New York time)

48 min: Is excess leverage behind this?

55:50: So what you’re saying is that they can’t run such a large deficit.  In a recession they could run a larger deficit.

1hr 01 min: To me, it smacks of leverage (from hedge funds)

1 hr 04 min: Why is the (Fed) balance sheet affecting equities?

According to Basel 3, Banks need assets at the Fed to participate in Repo market

  • A lot of banks weren’t able to participate  in the repo market,
  • This affected the hedge fund’s ability to use leverage from borrowed repo money
  • The repo market is the liquidity factor for leverage
  • Higher repo interests spikes (2% -> 10%) caused the hedge funds to liquidate their positions
  • The equity rallies are a direct consequence of the Fed Repo Liquidity
  • Hedge funds are using the liquidity

The Fed is now going to be permanently involved.  They messed up and now are going to oversupply, which they don’t view as a big problem.

1 hr 10 min:  Treasury Securary Mnuch announced ..

They have tons of ammo to dump money into the economy right before the election.

Bond yields are collapsing.

If the US Dollar Collapses, European and Japanese will not be able to play in Equities so much and Equities could fall.

  • Euro Dollar funding depends on Basel 3 regulations

1 hr 14 min:  A steeper yield curve helps foreign buyers of Treasuries

  • This means that they will likely have to cut rates (given corona virus and deficits)
  • They will probably be forced to cut rates soon.

Bonds give better signals about the economic cycle than Stocks.

1 hr 18 min: It all depends on Treasuries (for equity) they have so much cash they can flood the market with $40 billion any time they want.  Their action is the biggest contributor to volatility.

Is Mnuchin essentially using this as an economic weapon in his ability to micromanage the economy? (before the election)

I don’t know but he has a lot of ammo.  It looks suspicious.  We should ask him in his press conferences.

If he decides he wants to put money in his checking, there’s nothing the Fed can do about it without blowing up the markets.

This is unprecedented except during the financial crisis.

Treasure has become the marginal provider of liquidly and that who we should watch.

The Treasury General Account is the “nuclear weapon”.

There is a potential dollar collapse in the future.  Markets can’t get enough dollars.