Although there is no interest rate cut, we are still taking good care of it!
The interest rate of the US dollar is not clear. Fed Harker said last night that the necessary confidence is still lacking and uncertainty has not been completely eliminated. The long-term stubbornness of housing inflation is still worrying, as is inflation in the service industry. The Fed may cut interest rates twice or not at all, and is currently facing uncertainty. However, the liquidity in the United States seems to be in sharp contrast with the liquidity of offshore US dollars.
According to data released by the New York Fed on June 17, local time, the Fed accepted a total of $333.429 billion from 66 counterparties in fixed-rate reverse repurchase operations. This is $50 billion less than the data released on June 14 and nearly $110 billion less than the data released on the 12th.
So, what does this mean? The Federal Reserve's overnight reverse repurchase (ONRRP) is handed over to the New York Federal Reserve for daily operations. The decline in the scale of its reverse repurchase means that liquidity is moving in the direction of loosening, and vice versa, it is moving in the direction of tightening. At present, this downward data may be an important boost to the continued strength of US stocks. After the 2008 financial crisis, the Federal Reserve has continuously improved its interest rate corridor to continuously improve and stabilize the financial system, which may also be the key to the United States' financial advantage.
The journey back home
After the COVID-19 outbreak in 2020, the United States began a large-scale monetary easing policy. The Federal Reserve released money crazily, causing interest rates to fall to a very low level. This easing period lasted until August 2021. As the epidemic improved, after August 2021, the Federal Reserve's overnight reverse repurchase began to gradually increase in volume, which means that the Federal Reserve is recovering liquidity in the market. It was also from that time that the US dollar gradually strengthened, and US stocks and bonds gradually weakened. In 2022, US stocks fell for nearly a year.
On December 29, 2022, the data peaked and fell back (it was more than 2.3 trillion US dollars at its highest). During the bankruptcy crisis of small and medium-sized banks in the United States in 2023, the operation was intensified, sufficient liquidity was released to the market, and a downward trend was officially established in May of that year. As of June 17, the scale has dropped to 333.429 billion US dollars. Recently, the data has been below 400 billion US dollars. From the trend, it can also be found that the data is returning to before August 2021.
During the same period, the Nasdaq has been rising since January 2023. So far, the index has nearly doubled.
However, in this process, we have not seen any relief in the offshore US dollar liquidity pressure. The US dollar index is still around 105, and the US dollar against non-US currencies such as the Japanese yen continues to rise. At the same time, the Federal Reserve has not cut interest rates. In the context of inflation, the Federal Reserve relies on expectation management and technical operations to maintain the valuation of huge US stock assets. As a result, there is a clear difference between the liquidity of the US dollar in the United States and the international liquidity.
Why is the effect so good?
According to data, in the United States, reverse repurchase refers to the operation in which the Federal Reserve sells securities to the counterparty to "get money" and agrees to buy back the securities from the counterparty after a certain period of time. This operation can recover liquidity from the market and increase short-term interest rates. Correspondingly, the decline in the scale of this operation also means that the scale of liquidity recovered by the Federal Reserve from the market has become smaller, liquidity has moved in the direction of easing, and short-term interest rates have moved in a downward trend.
In 2008, after the financial crisis, excess reserves began to generate interest, and the combination of two other factors also led to the effective federal funds rate (EFFR) starting to be lower than the interest rate on excess reserves (IOER). The large amount of excess reserves brought about by quantitative easing weakened the demand for deposit institutions to borrow. However, not all financial institutions can participate in IOER, including government-supported institutions such as the Federal Home Loan Bank, which cannot obtain IOER for excess funds because they do not have reserve accounts at the Federal Reserve. Therefore, these financial institutions are more willing to lend funds at an interest rate lower than IOER, which in turn leads to EFFR being lower than IOER.
CICC said that since IOER became the upper limit of the interest rate corridor, the Federal Reserve launched the overnight reverse repurchase agreement (ONRRP) in 2013 and used it as the new lower limit of the interest rate corridor. The mechanism behind it is that if the EFFR is lower than the ONRRP interest rate, then financial institutions will receive interest from the Federal Reserve through overnight reverse repurchase. Similarly, if the ONRRP interest rate is lower than the EFFR, financial institutions will have the motivation to borrow funds.
Moreover, the Fed's reverse repurchase operations have a wider scope of application, and counterparties include primary dealers, money market funds, banks and financial institutions including government-supported enterprises, so they can meet shorter-term needs. This explains why reverse repurchases surged after the expiration of the bank supplementary leverage ratio exemption.
Monetary normalization = interest rate cut?
So, does the gradual return to normalcy in the US domestic money market mean a rate cut? In fact, the Federal Reserve has not given a clear standard, so expectations are still vague.
Experts hope that the Fed is still considering two rate cuts. Neel Kashkari, CEO and president of the Minneapolis Fed, believes that it is "reasonable" for the Fed to wait until December (after the 2024 election) to start cutting interest rates. Patrick Harker, president of the Philadelphia Fed, said that one rate cut before the end of the year is his current base case forecast, and he still lacks the necessary confidence and has not completely eliminated uncertainty. The long-term stubbornness of housing inflation remains a concern, as does inflation in the service sector. It is possible for the Fed to cut interest rates twice or not, and it is currently facing uncertainty.
From the history of the US dollar, the Fed's interest rate cuts often occur when a crisis is coming. At present, the US economy is still strong, with an unemployment rate of only 4% and inflation gradually declining. Moreover, from the perspective of the stock market, due to the magic operation of reverse repurchase, the stock market continues to rise, and the situation looks very good. Under this background, from the perspective of game theory, as long as the US Treasury market can be maintained, the Fed's motivation to cut interest rates may not be strong.
Of course, there are variables in this process. The suspension of the US debt ceiling will end on January 1 next year. Since such events have had a relatively large impact on the Treasury market before, there may be some changes in the reverse repurchase market before this. Some investors and strategists said that they may consider depositing more cash in the Federal Reserve's overnight reverse repurchase agreement tool (RRP). Although RRP has a lower yield, it is safer and more liquid than other investments. As a result, the scale of reverse repurchase will increase, and the liquidity in the United States may shrink.
