March 23 - The Day Massive Stimulus for Corona Crisis Occurred

David Goldsmith

All Powerful Moderator
Staff member

What’s Behind the Huge Spike in Reserves, a Liability on the Fed’s Balance Sheet?​

The New Regime at the US Treasury Department.

The reserve balances that commercial banks have on deposit at the Fed have spiked by $1 trillion since July, and by $333 billion over the past four weeks, including $89 billion in the week through Wednesday, to a new record of $3.6 trillion. These are liabilities on the Fed’s balance sheet – money that the Fed owes the banks – and the Fed currently pays the banks 0.1% interest on those reserves. What’s behind this huge spike?

Since March last year, the US government debt – Treasury securities outstanding – has ballooned by $4.4 trillion, to $27.9 trillion currently. The government sold these Treasury securities to borrow the funds it expected it would need to cover the deficits and stimulus packages. But it hasn’t spent all $4.4 trillion.
Some of it is still sitting in its vast checking account at its bank, the Federal Reserve, specifically the New York Fed. The balance in this “Treasury General Account” (TGA) spiked from around $400 billion in January and February 2020 to $1.79 trillion at the end of July 2020, as the funds raised from the enormous debt sales at the time weren’t spent as fast as they came in.

The New Regime inherited the TGA with $1.6 trillion in it. And it decided to draw down this balance to around $500 billion by the end of June, thereby reducing the balance in its checking account by $1.1 trillion. And so the government has reduced the amounts of Treasury securities to be sold at the scheduled auctions.
Over the past four weeks, the balance in the TGA account has already dropped by $266 billion, including a massive $110 billion in the week ended Wednesday:

The Fed, as any bank, carries customer deposits as a liability on its balance sheet. By contrast, the QE events – the purchases of Treasury securities and MBS, the repos, swaps, and SPV loans – are happening on the asset site of the balance sheet. But the TGA is on the liability side, money that the Fed owes the government.
So the government is using the funds in the TGA to pay for its deficit spending, including the $600 stimulus checks that were sent out starting at the end of December.
Drawing down TGA makes sense. The government doesn’t need to have all this much liquidity sitting in its checking account, while at the same time carrying this huge debt.
As a result, the government’s debt has declined since March 1, to be roughly flat with mid-February; and in January, it has risen more slowly than the horrendous spike that started in March, despite the red-hot pace of spending.
The insert in my Debt-out-the-Wazoo chart shows the details over the past three months. Obviously, drawing down the TGA balance represents just a minor and temporary slowdown in the incredibly spiking US National Debt:

The Treasury Department is reducing its checking account balance by spending this money faster than it is raising funds through new debt sales. When the government sends out a tax refund check or a stimulus check or pays for a contract, these checks or electronic transfers arrive at the recipients account at a commercial bank. The bank then presents them to the Fed for payment from the TGA.
The bank can then choose to add those funds temporarily to its reserves on deposit at the Fed. In this situation, the funds are effectively moved from the TGA account (money the Fed owes the government, a liability on the Fed’s balance sheet) to the Reserves account (money the Fed owes the banks, also a liability).
And you guessed it, as the balance in the TGA has plunged, the reserve balances on deposit at the Fed have spiked to a new record of $3.6 trillion. See the first chart above.
So this process of reducing the government’s TGA account balances has the roundabout effect of replacing Treasury securities on the banks’ balance sheets with reserves – sheer outright liquidity.
But there are all kinds of side effects, with so much Fed-created liquidity washing through the system, and changing hands, creating these massive distortions.
The current turmoil in the repo market is part of those side effects. This time around, the turmoil is the opposite of what it was in late 2019. Back then, repo rates had panic-spiked to 5%, 6%, and higher as lenders had pulled away, and forced borrowers were getting desperate. The Fed stepped in as lender of last resort to bail out these forced borrowers — such as hedge funds and mortgage REITS — which calmed down the repo market.
But last week, repo rates, particularly those of recently issued 10-year Treasury securities, dropped deeply into the negative.
A repo is a repurchase agreement, whereby one party lends cash in exchange for securities as collateral; and the counterparty borrows this cash and posts the securities as collateral. When the repo matures, the transaction reverses. The lender gets the cash back plus a little interest, and returns the securities to the borrower.
What happened last week was that there was so much demand in the repo market – not for cash, as in the fall of 2019 – but for these recently issued 10-year Treasuries. Participants (effectively the lenders) bid up the price of the Treasuries so high that their yield turned negative to -4.5% for them. In other words, they had to have the Treasuries, and didn’t care about how much they had to pay to get them.
Borrowers who supplied those Treasuries as collateral then – instead of paying interest on the amount of cash they borrowed, as normal – were paid 4.5% to take the cash and post the Treasuries as collateral.
If the Fed had wanted to step into the repo market this time, it would have had to sell Treasury securities into the market to create more supply, effectively borrowing from the repo market (reverse repo), to bring rates back up into the positive – rather than lending to the market by buying Treasury securities as it had done in the fall of 2019 when the rates blew out.
And that sudden selling by the Fed of its Treasury securities, ladies and gentlemen, would have been a hoot to behold. And so the Fed did nothing and let things play out.
The deeply negative repo rates on 10-year Treasuries have raised concerns in certain corners of Wall Street that otherwise clamor for more QE that the Fed has pushed QE too far, and that some aspects of the markets are starting to malfunction.

David Goldsmith

All Powerful Moderator
Staff member
It's a good thing we fixed the system which led to the 2008 financial meltdown so it could never happen again.
Issuance of Bundles of Risky Loans Jumps to 16-Year High
A recovering economy, demand from yield-starved investors boost collateralized loan obligations

Sales of securities backed by bundles of risky corporate loans are hitting records, lifted by a recovering economy and demand from yield-starved investors.

Issuance of new collateralized loan obligations, which buy up loans to companies with junk credit ratings and package them into securities, totaled over $59 billion as of May 20, according to data from S&P Global Market Intelligence’s’ LCD. That is the highest ever figure for that period in data going back to 2005.

The prospect of rising inflation and a shift away from the Federal Reserve’s easy money policies are making bonds tied to so-called CLOs attractive to a wider range of investors, analysts said. Many are expecting strong growth to prompt Fed tightening, eroding returns on corporate bonds. Yields on CLO bonds typically rise with interest rates.

The CLO market’s record sales pace marks a reversal from this time last year, when pandemic fears caused debt prices to plummet, freezing sales of new funds. Support from the Fed, including cutting interest rates to near zero and buying the highest-quality bonds from certain types of CLOs, has since helped bring investors back.

A pre-markets primer packed with news, trends and ideas. Plus, up-to-the-minute market data.

CLOs have become a $760 billion market, accounting for 70% of new leveraged loan purchases last year, according to Citi. Because CLOs’ loan holdings are diversified, the bonds can achieve higher credit ratings than the underlying loans, making them popular among institutions restricted to investment-grade debt, such as banks and insurers.

At the same time, the economic rebound is improving the prospects of many companies whose loans are bought by CLOs. Just six nonfinancial, junk-rated companies defaulted during the first quarter of this year, according to Moody’s Investors Service—the lowest level since 2018. The ratings agency expects the trailing 12-month default rate to fall to 3.9% by the end of December, from 7.5% in March.

Ratings firms are now putting some CLO securities on review for possible upgrade, which analysts say could spur demand in the months ahead.

“That supports the CLO market because investors see much less tail risk as those issuers get upgraded,” said Tom Shandell, chief executive of Marble Point Credit Management, which manages $6.2 billion in assets, including CLOs.

“The default environment has been very benign and will be because the capital markets are open to companies that may be struggling a little bit,” he added.

The combination has analysts and investors expecting a banner year for CLO issuance. Bank of America projects sales to total around $360 billion this year, including refinancings, while Citibank expects around $290 billion. Both figures would surpass 2018’s all-time high.

“You’re going to see a ton of activity in the next few months,” said Ryan Kohan, loan portfolio manager at Western Asset Management.

Critics say CLOs allow companies to borrow more than they can support, exposing investors to losses in a downturn. A wave of leveraged loan downgrades hit CLO managers last year, causing some portfolios to surpass limits on low-rated holdings or breach collateral tests.

Some investors are hesitant to add to CLO holdings. As of Friday, the average triple-A rated CLO bond issued in May paid an extra yield, or spread, of 1.16 percentage points over the London interbank offering rate, or Libor, according to Refinitiv. That is above the record low of 0.98 from March 2018 but down from 1.31 points in December.


David Goldsmith

All Powerful Moderator
Staff member

Why demand for Fed’s reverse repo facility is surging again
A key artery of global financial markets may be telling the Federal Reserve that enough is enough.
Demand for an overnight funding through the Federal Reserve Bank of New York’s overnight reverse repo program (RRP) has begun to flirt with recent records highs, after almost no one used it for months.
Daily repo usage jumped to $394.94 billion on Monday after topping $369 billion on Friday, its highest level since the end of June 2017, according to Tradeweb data.
The Fed’s reverse repo program lets eligible firms, like banks and money-market mutual-funds, park large amounts of cash overnight at the Fed in exchange for a small return, which lately has fallen to about 0.06%.
The program had almost no customers in early April, and few since the pandemic’s onset last spring, but daily demand in recent weeks has shot up dramatically. This chart shows the spike in reverse repo demand since April 1.
chart, histogram: Spike in reverse repo demand
© Curvature Securities Spike in reverse repo demand
“Why are they going to the Fed?” asked Scott Skyrm, executive vice president in fixed income and repo at Curvature Securities, of firms wanting reverse repo funding, despite its dwindling returns.
“Either there is too much cash or not enough collateral,” he told MarketWatch. “It’s two sides of the same coin.”
It’s also pretty much the opposite of what happened in September 2019, when repo rates suddenly skyrocketed, resulting in the Fed jumping in with a slate of short-term emergency lending facilities that helped calm fears that financial markets might otherwise freeze up.
This time, Skyrm views high demand for the Fed’s low-return reverse repo facility as a sign that the central bank’s roughly year-old $120 billion-a-month bond-buying program no longer works as intended by adding liquidity to financial markets, and should be scaled back.
“Right now, the more money you put in, you get it right back,” he said. “The market is saying ‘It’s time.’ There is the evidence that QE has gone too far.”
This chart shows the recent spike in reverse repos at the Fed as nearing peak levels of the past decade.
chart, histogram: Demand for reverse repos nears peak levels
© BTIG Demand for reverse repos nears peak levels
The Fed, under Chairman Jerome Powell, has purchased $2.5 trillion in bonds since the pandemic broke out last year, through its monthly purchases of U.S. Treasurys and agency mortgage bonds, or “quantitative easing” (QE).
“This adds liquidity to the system. As the Fed buys bonds, those sellers receive the liquidity and likely buy other bonds, or other product,” Padhraic Garvey, ING’s global head of debt and rates strategy, wrote in a client note Monday.
“The thing is, the liquidity is being placed here as there is nowhere else for it to go to,” Garvey wrote of the Fed’s reverse repo program. “And it’s not really where you want to park cash, given that the rate paid to the cash lender is 0%.”
Overnight reverse repo rates have been sinking to the low end of the Fed’s target policy rates, currently in the zero to 0.25% range.
As MarketWatch reported in April, the worry is that the U.S. central bank could be on the brink of losing control of its benchmark policy rates, without making other tweaks to stabilize rates.

Meanwhile, Powell has promised “great transparency” around the Fed’s eventual exit of easy monetary policies. Several Fed officials recently called for the central bank to start discussing a slowdown of its bond purchases, while the latest minutes of the rate-setting committee meeting showed a willingness to explore the topic in coming meetings.
A BTIG Research team led by Julian Emanuel described the situation like a game of cat and mouse.
High demand for the Fed facility “underscores pressures on the short end of the yield curve as near-term rates probe negative territory after a year-plus of extraordinary accommodative policy,” the team wrote in a Sunday note.
But they also expect the issue to last “until investors are confident enough to shift to longer-duration bonds,” which isn’t expected to happen until markets get more clarity on the Fed’s plans to taper its bond purchases.

David Goldsmith

All Powerful Moderator
Staff member

David Goldsmith

All Powerful Moderator
Staff member
I expect a final melt up phase, which we are in early stage of now, and expect a quick pop with fiscal coming that will push us to farther record highs. It will get stupid and silly, and be fast. From that top, whenever it is, I expect a crash of 40-50% or more to take place over a quick period as the bubble pops. It will all be fast. From then, I think we embark on a longer term sustainable trend higher with inflation picking up mid and later in this decade. Built credit spread to help time these moves so I can plan accordingly.

U.S. Junk Bond Coupon Sets Record Low in Race to Rock Bottom​


Noah Rosenblatt

Talking Manhattan on
Staff member

U.S. Junk Bond Coupon Sets Record Low in Race to Rock Bottom​

Indices at/near record highs. Corporate bond market at/near record levels. As you note, credit spreads at historic lows. What could possibly go wrong (hint: look at crypto, lumber, speculative day trading stock charts for clues) - use this for guide to when the party is over. If index goes to right and we enter stage 2, watch out


David Goldsmith

All Powerful Moderator
Staff member

Opinion: One look at junk bonds tells you that stock investors now are too bullish​

Here’s another indication that investors now are dangerously exuberant: The junk bond spread has rarely been lower than where it stands today.
That’s worrisome because past occasions of a low junk bond spread have often preceded periods of economic trouble, if not actual downturns. As a result, low junk bond yields typically don’t stay low for long.
The junk bond spread is the difference in the yields of junk bonds and those of Treasurys of comparable maturities. It represents the compensation that investors are demanding for incurring the additional risk of holding junk bonds instead of Treasurys. When the spread is low, like it is now, investors are behaving as though holding junk bonds involves relatively little additional risk.
The chart below shows where the junk spread stands today relative to its history since the 1990s. It currently is 3.4 percentage points, well-below the 25-year average of 5.5 percentage points. As you can see, there have been only two other sustained periods since the mid-1990s when the junk spread got as low as it is today: Prior to the bursting of the internet bubble and just prior to the Great Financial Crisis.

To be sure, as the chart also shows, the spread briefly got as low as it is today in 2014 and 2018, and neither occasion presaged an economic recession. Nevertheless, in each case the spread almost immediately widened considerably, more than doubling.
It would be particularly ominous if such a doubling were to occur today, given the fragile state of U.S. corporate balance sheets. As I’ve pointed out before, most companies are barely profitable; the bulk of the profits collectively earned by all publicly traded corporations are concentrated in the 100 most profitable firms. In 2020, for example, among companies in the S&P 1500 index, this proportion was 91.8%.
Since most of the companies outside of the top 100 are not consistently profitable from year to year, many of their debt ratings are already in the “junk” category. So if the junk spread were to widen considerably, many of them would have grave difficulty paying their debt-service costs — even if Treasury yields stayed low.
To determine the likely course of the junk spread, I measured the correlations between its level at any given time and how much it rises or falls over the subsequent quarter-, year- and two-year periods. In all cases there was an inverse correlation, meaning that the junk spread is strongly mean-reverting: high spreads are more often than not followed by lower ones, just as low spreads are far more often than not followed by higher ones. These correlations are all significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine.
Particularly noteworthy is that correlations are stronger at the two-year horizon than at the one-year horizon. Correlations for the one-year horizon are in turn stronger than for the one-quarter horizon. That’s significant because most other sentiment indicators have their greatest explanatory power at the one-quarter or shorter horizon. So the junk bond spread is one of those rare contrarian indicators that can help us gauge longer-term prospects.
Assuming the future is like the past, we therefore can predict with some confidence that the junk spread is likely to be much higher than where it is today with a couple of years. It’s not unlikely that an economic recession will occur in the next couple of years, but even if that’s not the case, companies with lower debt-quality ratings will face much higher debt service costs. Those investing in junk bonds could incur substantial losses. Plan accordingly.

Noah Rosenblatt

Talking Manhattan on
Staff member
Completely agree. Credit spreads are historically very low from Fed interventions in credit markets and QE and other liquidity programs, this causes a MASSIVE search for yield anywhere investors can find it and ofc creates environments like these. It all goes well until it doesnt.

We built to warn us on this very thing, as we do believe a bust is coming at some point to normalize pricing of risk, etc.


David Goldsmith

All Powerful Moderator
Staff member
I expect a final melt up phase, which we are in early stage of now, and expect a quick pop with fiscal coming that will push us to farther record highs. It will get stupid and silly, and be fast. From that top, whenever it is, I expect a crash of 40-50% or more to take place over a quick period as the bubble pops. It will all be fast. From then, I think we embark on a longer term sustainable trend higher with inflation picking up mid and later in this decade. Built credit spread to help time these moves so I can plan accordingly.
Where are we now given inflation officially at 7.5% (and if we use 1980s methodology probably more than double that)?