$2T Stuffed Under the Mattress...
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Financial Plumber
When I first started working at Goldman Sachs, it was my job to cash settle transactions with other firms engaged in securities lending activities (short selling).
I would monitor the positions of various short sellers during open market hours.
If the markets moved against any of our short selling counterparties, my screens would light up like a Christmas tree and I would notify the trading desk of a cash imbalance.
With the traders approval, it was my job to go out and request additional cash to be wired intraday to cover outstanding balances.
Not every account needed to settle in cash, only the riskier ones.
Some accounts would simply swap US treasuries and balance collateral near the market close. (Those analysts had the easier job with the top accounts…)
At the end of the day, we would reconcile cash and collateral accounts.
The total aggregate amount in treasuries would then be sent to a Tri-Party sweep and held with the Federal Reserve overnight.
This last transaction is also known as the Tri-Party Repo Market.
The Tri-Party Repo market has increased significantly since I was there.
While the repo markets allow investors to manage excess cash balances safely and efficiently, the job was not glamourous.
I was essentially a plumber in the financial machine.
At the time, I did not recognize that I was learning valuable lessons that could apply today.
I learned the ebb and flow of open market operations and the inner “plumbing” of our capital markets.
I also learned how things could go wrong and what could be done to fix it.
Why $2T in Reverse Repo is a Problem
In the example above, I outlined the process of closing each trading day with a Tri-Party repo transaction held overnight with the Federal Reserve.
Currently the system is backwards… it’s an issue.
Every morning, firms now wait and see if the Federal Reserve will release cash from the Reverse Repo market.
Reverse Repos are carried out by the Federal Reserve in order to temporarily remove liquidity from the financial system and control the amount of money in the system.
Since the beginning of the year, over $2T in cash been up bought up by the Federal Reserve, with the goal of keeping inflation under control.
The current rate of 2.30% is paid in interest by the Federal Reserve to keep money out of the system.
This is one of the reasons why I believe gold has been underperforming this year.
The Reverse Repo market, paying 2.30% to lock-up cash, is a much better deal for banks to invest in, when compared to gold.
This is because gold does not pay a dividend.
I do not think gold will be an attractive investment until the Reverse Repo Facility begins to unwind.
The problem is the Fed can only pay to keep cash “under the mattress” for so long.
The interest the government pays for the Reverse Repo is expensive.
On top of it all, inflation increased according to the latest monthly report.
The Fed’s Shell Game
The Fed’s current plan is to release the Reverse Repo steadily giving cash back to the banks and reduce the Fed’s own balance sheet holdings.
This is why the quantitative tightening cap is set at $95B every month for the next two years.
$95B x 12 months x 2 years = $2.2T
(the amount currently held in the Reverse Repo).
This plan has many open critics, including myself.
The Fed has also considered other alternatives such as:
Increasing the amount of shorter term T-bills to be issued
Completely regulating all secondary treasury “off-the-run” transactions.
If you don’t already follow Scott on Twitter, it is well worth the follow.
Ok, but what does all this have to do with my 401k?
In normal market conditions, the U.S. Treasury market has functioned extremely well.
Even under stress, the market generally has been highly resilient.
However, several episodes in the U.S. Treasury market, including the “flash rally” of 2014, the U.S. Treasury repo market stress of September 2019, and the COVID-19 shock of March 2020, have raised questions about the U.S. Treasury market’s continued capacity to absorb shocks and what factors may be limiting the resilience of the U.S. Treasury market under stress.
Although different in their scope and magnitude, these events all generally involved dramatic increases in market price volatility and/or sharp decreases in available liquidity.
Quantitative easing clearly boosted financial assets.
Quantitative tightening will most likely have a negative effect on financial assets.
The Reverse Repo facility is supposed to act as a “pressure value” to keep financial assets up and slowly release cash back into the system over time.
My experience suggests this will be difficult to pull off effectively.
If the Fed decided to release all the cash in the Reverse Repo tomorrow, it would be catastrophic and result in runaway inflation.
The ability for the Fed to unwind the Reverse Repo facility in a timely manner without causing more rampant inflation is the tight rope we are all walking on today.
For some investors this is a risk they are willing to take.
For others this is not.
If you haven’t already considered investing in a truly diversifying portfolio, consider assets that can benefit under a longer inflationary period.
You can read more about Tuttle Venture’s current portfolio holdings, which remain unchanged and open for paying subscribers here.
Final Word
Thank you for reading and I am grateful and humbled to be able to learn, grow and invest alongside you at Tuttle Ventures.
Vision, Courage and Patience leads to successful investing.
Don’t forget to follow Tuttle Ventures on Twitter, LinkedIn or Instagram.
Check out the website or some other work here.
Best,
Darin Tuttle, CFA
NOTE - This is not investment advice. Do your own due diligence. I make no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in this report. Any assumptions, opinions and estimates expressed in this report constitute my judgment as of the date thereof and is subject to change without notice. Any projections contained in the report are based on a number of assumptions as to market conditions. There is no guarantee that projected outcomes will be achieved. Unless there is a signed Investment Management or Financial Planning Agreement by both parties, Tuttle Ventures is not acting as your financial advisor or in any fiduciary capacity.