Monthly Archive: July 2021

Central bank digital currency is more effective than cash

Spark Global Limited reports:

In a new research note, Bank of America argues that central Bank digital currencies (CBDCS) are “a more efficient payment system than cash” and could well replace cash in the future.

Spark Global Limited reports:

The report comes at a time of heightened interest in the CBDC among central banks. A previous survey by Bison Trails, a blockchain infrastructure platform, found that about 80 percent of central banks are exploring use cases involving CBDCS, and 40 percent of them have tested proof-of-concept programs.

Bank of America says the adoption of CBDCS is “inevitable,” citing the declining role of cash, the private sector’s growing use of blockchain technology, the loss of control over money, and the potential for CBDCS to boost the economy. The bank also noted that central banks that have not launched their own digital currencies could see less demand for their money.

On the other hand, the report highlighted the central bank’s “very cautious approach” to concerns that CBDCS could compete with bank deposits, spur bank runs and harm personal security.

Former Trump economic adviser: Financial crisis in 18 months

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The us government’s excessive fiscal spending and soaring national debt could trigger a financial crisis in the next 18 months, Stephen Moore, a prominent economist and former Trump campaign economic adviser, warned on Wednesday.

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In addition to growing debt, he notes, the risks are exacerbated by a massive misallocation of resources. Generous federal benefits, for example, discourage people from working.

Many business owners across the country have been complaining that their jobs are not attractive to job seekers in the face of federal unemployment benefits. Supplemental unemployment benefits introduced during the pandemic have been cited as one of the key reasons for severe labor shortages in the United States.

Moore says these plans run counter to the welfare reforms of the mid-1990s, which required welfare recipients to work in order to receive benefits.

Biden plans to make 40 percent electric by 2030

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As the Biden administration works to reduce greenhouse gas pollution, the White House has told U.S. automakers it wants them to support a voluntary commitment to make at least 40 percent of new car sales electric by 2030, according to media reports citing people familiar with the matter.

As early as next week, the Biden administration is expected to unveil a revised version of vehicle emissions standards through 2026. The voluntary electric vehicle (EV) target could be as high as 50 percent, sources said, but no agreement has been reached with automakers and many details are still being discussed, including whether the commitment will include a variety of gas-electric hybrids.

Biden’s proposed rules, which would cover 2023 to 2026, are expected to be similar in terms of overall vehicle emissions reductions to California’s 2019 deal with some automakers aimed at improving fuel economy by 3.7 percent a year, the sources said. The new rules are expected to exceed the 5 percent annual increase under Obama.

The main iron ore contract fell more than 7 percent

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On Thursday, the main iron ore contract briefly fell below 1,100 yuan a tonne, down nearly 3 percent to its lowest since June. In Asia on Friday, the main iron ore contract continued to fall, down 80 yuan on the day, to 1038 yuan/ton around, down 7.16%.

According to the Ministry of Finance website 29 news, in order to promote the transformation and upgrading of the iron and steel industry and high-quality development, approved by The State Council, The State Council Tariff Commission issued a notice, from August 1, 2021, the appropriate increase in the export tariff of ferrochrome, high purity pig iron, after the adjustment of 40% and 20% export tax rate.

Three signs indicate that A – share market liquidity or will continue to tighten pattern

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A – share violent shock background, institutional capital flow continues to tighten.

On the foreign side, short-term panic selling has basically ended, but there is no obvious repatriation of overseas long-term funds, and overseas China funds have recently faced continued redemption pressure.

In terms of domestic capital, according to the channel research data of Citic Securities, the average daily net redemption rate of stock public offering products in July was 1.9 times that of June. Although the structure of new growth style funds is hot, and the recent market volatility leads to a slight decline in the net redemption rate of stock funds, but the overall situation of new issuance and stock redemption is comprehensive. In July, the net outflow from public offering institutions continued to increase compared with the second quarter.

In terms of institutional positions, public offering continues to maintain the high position since June, while small private placements and hot funds continue to increase their positions significantly since the beginning of July. At present, mainland institutional positions are close to the high level of Q1.

Short-term panic selling of foreign investment is basically over, long-term funds in July net outflow of A share market

1) In the stage of rapid market adjustment, panic selling occurs in both allocation and trading types. From Friday to Tuesday, both the allocation type and the transaction type showed the characteristics of panic selling similar to that during the outbreak of the epidemic in March 2020, with a large net outflow of their heavy position industries. During the allocation capital period, the main holdings of food and beverage (-2.4 billion), power equipment and new energy (-1.4 billion), home appliances (-1.3 billion), etc. In addition, influenced by the effective elimination of Chinese military enterprises by FTSE Russell, the allocation capital significantly reduced its holdings of national defense industry (-4 billion); During the period of transaction capital, the holdings of banks (-1.6 billion), computers (-1.5 billion), basic chemical industry (-1.2 billion), and non-bank finance (-900 million) were mainly reduced.

2) The panic selling has basically ended, and the large return of foreign capital is mainly transactional funds, while the allocation funds have no obvious signs of return. On Wednesday, the net inflow of capital to the north exceeded 10 billion yuan, of which the transaction capital returned 10.4 billion yuan. The main net inflow was food and beverage (+ 2.6 billion), power equipment and new energy (+ 1.8 billion). In contrast, the small net outflow of allocated funds is less than 10 million yuan, without obvious signs of reflux. In fact, from April to July this year, the net inflow of allocated funds was +507 billion yuan /+372 billion yuan /+299 billion yuan / -5.6 billion yuan, showing a decreasing trend month by month, among which the net outflow in July was the first since October 2020.

From industry configuration, configuration fund in this month last underweight a-share current electric power equipment and new energy (up to – 2.5 billion), over the past two years with the continuous breakthrough its historic peak valuations, the configuration type funds continue to steadily accumulating new energy stocks, the corresponding positions have risen from 2.7% at the end of 2019 to 11.7% in the current, Is second only to food and beverage heavy warehouse industry, so similar to this month’s sustained reduction is rare.

3) Overseas China equity funds have seen six consecutive weeks of net redemptions since late June. Net redemptions of overseas China Equity funds reached 0.39 percent in the latest week (July 21-28), according to Thomson Reuters data. While down from the peak of 1.2 percent in March 2020 during the outbreak, it is the highest level of net redemptions since April last year. Suggesting that foreign institutions may face continued redemption pressure.

In July, the public offering institutions foreclosure fund flow further tighter than the second quarter

1) The scale of the new Development fund established in July exceeded 100 billion yuan for the first time since the second quarter, but the structure is biased to the growth manufacturing style. As of July 28, the newly established scale of active equity public offering funds was 112.5 billion yuan, 16.2% higher than the total scale in June, which was the first time that the monthly scale exceeded 100 billion level since the new development was cooled in April this year. The average issuance scale in the past three weeks was 2.1 billion yuan, which was the first time that it exceeded 2 billion yuan since the second quarter. Channel research shows that the current new development fund heat structural bias to growth style products, rather than growth style product release is still cold.

Taking 25 funds with a scale of more than 1 billion RMB established from July 19 to 28 as samples (total size 86.1 billion RMB), the samples were divided according to the customized style bias of funds or the past product style of fund managers. The number of growing or emerging products accounted for 60.0%, and the size accounted for 61.7%. In contrast, the number of consumption and cycle style products accounted for 8.0%/8.0% respectively, and the size accounted for only 2.4%/3.7%, and the average release size was lower than the overall mean of the sample, less than half of the average size of growth style products.

2) The net redemption rate of outstanding funds has shrunk significantly during the recent market adjustment, but the overall net redemption rate in July has reached a new high this year. According to the channel research data of Citic Securities, as of July 28, the average daily net redemption rate of active equity public offering funds in July was 1.99 times that of June, and the average daily redemption rate was 2.57 times as of July 16, which shows that the net redemption rate of stock funds has shrunk significantly in the process of the market volatility since last week. In line with our consistent emphasis on the “market decline in the net redemptions of base people on the contrary low” view, so we do not think that the market decline will trigger fund redemptions into the negative feedback of passive selling.

But from the absolute level of net redemptions, this month’s public offerings facing redemptions pressure is indeed this year’s peak. According to our calculation, the overall fund flow scale of public offering institutions in July was -227.5 billion yuan, significantly higher than the monthly average of -12.2 billion yuan in Q2.

Public – offering institutions slightly reduced positions, private – placement and hot capital continued to increase positions substantially

As of July 23, according to the measurement of quantitative allocation group of research Department of Citic Securities, the position of common stock/partial stock hybrid/flexible allocation fund changed +16/-45/-33bp respectively compared with the previous week, still maintaining the relative high since June.

According to our channel research, as of July 23, small private equity and hot capital continue to maintain the pace of rapid increase in position since the beginning of July, and the absolute position level is close to the highest level in the first quarter. From the perspective of domestic institutions, we believe that the subsequent incremental capital is relatively limited.

Global carmakers have complained, but the nightmare of missing cores will continue

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According to the financial data released by many global auto manufacturers recently, in the second quarter of this year, “epidemic” is no longer the ghost that haunts auto manufacturers, and “missing core” has become the biggest nightmare in the minds of global auto manufacturers. What’s worse, this nightmare isn’t going to end any time soon.

The nightmare of chip shortages continues

After hours Wednesday, Ford Motor Co. reported second-quarter earnings. Although the company reported an increase in profits, that was largely due to higher car prices — and on the production side, ford’s car production fell by half in the second quarter, largely because of chip shortages.

It was a similar story at Nissan, which reported earnings yesterday afternoon. Nissan’s chief executive said in an earnings call that the chip shortage affected production by as much as 500,000 vehicles in the first half of the fiscal year, and warned that the shortfall would continue to affect production and sales in the third quarter.

Volvo, which reported its highest first-half profit in 94 years, has not escaped the impact of a chip shortage. Volvo even suffered a month-long shutdown in the second quarter because of chip shortages. Martin Lundstedt, the company’s chief executive, said bluntly on the earnings call that the company would experience further disruptions or shutdowns in truck production in the second half of the year.

Earlier this month, BMW said it had lost production of about 30,000 vehicles so far this year because of the chip shortage, and that production would continue to be limited in the future, meaning billions of dollars in losses.

Ford, General Motors, Honda, Nissan and almost every other automaker in the world have periodically reported plant shutdowns due to chip shortages. On Wednesday, Daimler announced that it would cut production at its three Mercedes-benz plants in Germany and shut down its Hungarian plant for three weeks — not even news, after the market has been bombarded with news of factory closures for the better part of a year.

Us car and parts production contracted 22.5 per cent in the second quarter from a year earlier because of a “lack of core”, fed data showed. Us car production fell 6.6 per cent in June from a year earlier, weighing heavily on us manufacturing output. Less car production has also pushed up car prices. The average price of a new car in the US is now up 5.3% over the past year to an all-time high, according to Edmunds, the biggest driver of recent inflation in the US.

The Society of Motor Manufacturers and Traders (SMMT) said yesterday that chip shortages had forced the UK to produce just 69,097 cars in June, the lowest level since 1953 except last year. UK car plants produced 498,900 vehicles in the first half of 2021, 38.4 per cent below the average over the past five years — which equates to a loss of about £8.5bn.

The problem will limit global passenger car production by 5.2 million units this year and 8.1 million units between 2021 and 2023, according to data released by the German Center for Automotive Research.

How long will this nightmare last?

A recent industry report from electronic supply chain analysis firm Supplyframe shows that the global semiconductor shortage is likely to persist through the first quarter of 2023 and continue to constrain production in industries such as automobiles.

They pointed out that the shortage of chips in Taiwan has been exacerbated by the recent water shortage and the second outbreak of COVID-19, which have hampered local semiconductor production and closed testing.

Data from the Supplyframe survey also showed that many chip companies now have buffer stocks delivered to customers, while the average lead time for new chips is between 25 and 52 weeks, and in some cases can be as high as 60 weeks, meaning the chip shortage will not ease for at least more than a year.

Auto industry analysts at several institutions, including Goldman Sachs, generally expect supply of new and used cars to start “normalizing” only this fall as chip supply improves, but expect global auto inventories to remain well below average through at least the second half of 2021 and through 2022.

Disclaimer:
The copyright of this article belongs to the third party author. For authorization matters, please contact the original author. The opinions in this article are from the original author and do not represent the views and positions of Jin Shi. Special reminder, the content of this article is for reference only, not as practical operation advice, the risk of trading.

Most people probably get the real interest rate wrong

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The textbook will tell you that the real interest rate is the interest rate minus inflation, or the difference between the central bank’s interest rate and CPI inflation. But in fact, when applied to financial markets, real interest rates are more of an expectation, because financial markets themselves are talking about an expectation.

So you’re not looking at what the central bank is doing now, you’re looking at what the central bank is going to be doing in the future, a concept of interest rate expectations. We’re not looking at the current CPI data, we’re looking at a concept of inflation expectations, and there’s a very big difference between inflation expectations and inflation.

For example, if you look at the June CPI figures in the US, they were very high, so you say inflation is very high, that’s a very typical macroeconomic logic, and there’s actually a big problem with that. Because macroeconomic data tend to lag, June’s data were actually for May.

 

So, as a former trader, there is no way to trade published macroeconomic data. The actual data that comes out is actually used to verify, to verify that you made the correct predictions about inflation over the past month.

So how to judge expectations of nominal interest rates? The main loss is to observe the “smartest money” in the market.

Participants in the financial market have different structures, and the participation dimension of financial institutions and the market with large funds is very different from that of retail investors. For example, financial institutions will sink down through primary dealers in the bond market, generating different pricing on the transaction dimension of the bond market.

So when we look at central bank expectations, what are we looking at? You look at bond yields. Of course, when professional investors look at expectations, they also look at the maturity structure of bonds, short, medium or long.

Many people have a misconception that when a central bank speaks, it is very vague. It seems to have both the short end and the long end. What does he mean by that? For example, in the screenshot of the news media, he would say that the Federal Reserve said that the monetary policy would not move at the moment, but it cut the first half of the sentence, which sounds reasonable to you, but the central bank’s speech actually means that I will not move now, but I will move in the future. What is the focus of his statement?

If you just cut the first half, you would think that he doesn’t want to move, but in fact, has the market already priced in, has the market already recorded that he doesn’t want to move, is the market concerned about his future expectations? So listen to the listener, listen to him when he describes his current behavior as well as when he describes his future behavior.

So when we look at expectations, we’re really looking more at the smartest money, and you can understand that the smartest money is the money closest to the central bank system is pricing or what’s going on in the expected market.

So could they be wrong? Of course it does, but it corrects all the time, so you can see that it creates a fluctuation in time, and we can just look at the fluctuation and the trend of the fluctuation and make an estimate.

Inflation is actually an expectation. Where do inflation expectations come from? Watch commodity prices go up? Or am I going to watch prices go up around me? This is not what we mean by inflation in financial markets, especially since it’s very easy to confuse our own perception with inflation in financial markets, with inflation and inflation expectations, so it has to be accurate.

The price increases we feel are certainly inflationary, and it’s always inflationary. However, the inflation you feel in your life and the inflation you feel in the statistics are two different concepts. The inflation in the statistics may not be high, but the price of financial assets is high, and the inflation you feel is high.

We often joke that you have inflation for the poor and then you have deflation. Contraction means income is shrinking, income growth is slowing down, and up means you feel consumption is rising. There is no contradiction between the two.

As for the inflation in statistics, it more describes the back end, which can be understood as the growth rate of household income in the medium and long term. In fact, this is what is directly linked to the inflation in the medium and long term. Of course all economic questions ultimately extend to whether it can change or affect medium – to long-term income growth.

When you talk about inflation, you’re really talking about price transmission in the short term, from upstream to midstream and downstream. There is a pure price rise inside, called stagflation. What do you mean? Is the top price below not to accept. The economics textbook tells you that it doesn’t matter, if the downstream doesn’t pay, the upstream eventually has to lower its price.

This logic is not true in the real world, in the real world there is a special situation, if there is a problem with the supply, there is another situation, which is I will raise the price, I will sell higher, you buy like or not, you don’t buy you can go, I don’t sell. This kind of phenomenon is actually a little stagflation or kind of stagflation.

Essentially speaking, inflation is a phenomenon of demand, so why do we talk about the relationship between income and inflation, while stagflation is actually more of a supply, which is the supply side of the problem. And simple to see goods price inflation, is actually only took a half, because the prices of the goods is determined by supply and demand curve, which is short of normal, if can drive prices to demand the conduction of supply and demand curve, this is called inflation, but the supply and demand curve caused by supply factors among prices, even a form similar to squeeze in the form of a rise, it is stagflation.

So there’s a little bit of a subdivision that you need to do in terms of inflation alone.

Then changes in nominal interest rate expectations and changes in inflation expectations constitute changes in real interest rates. Real interest rate movements are crucial, and this is actually the core that dominates most financial assets.

For financial institutions, the first factor is not the situation of asset investment, but the first factor is the liability end. In short, it’s best if the asset side offers a good rate of return while the liability side changes.

This combination is essentially what we’re saying, if the cost of the debt side gets lower, nominal interest rates are low, inflation expectations imply real returns to the economy are high, then this combination is definitely going to be the most asset-friendly.

But the goodwill goes beyond the asset itself. For example, if you’re investing in stocks, a lot of people talk about value investing, but you know that the price of a stock is not just about value, it’s also about valuation, right? And at the short end, there’s a little bit of speculative psychology going on, and all of those things, together, make up the asset itself, make up the price that you see.

So when we talk about price, instead of just talking about price itself, you should make a distinction between when you’re doing valuation, when you’re doing value, when you’re making valuation money, and when you’re making value money.

What is closely related to the valuation here is actually the liability side. Simply put, the lower the cost on the liability side, the lower the implied real rate of return on the acceptable asset side will be, which in turn will lead to a higher valuation. The reason you’re willing to accept such a low real rate of return is because your debt side costs less.

If your cost on the liability side is 10%, 20%, how dare you accept an asset with an implied real return of 5%? No one would dare do that. The reason you’re willing to accept 5%, or even 3%, is because you have a lower cost of capital.

And this cost of capital is lower, in fact in the middle of the financial market means that the real interest rate is too low. For example, we often refer to excessive liquidity, excessive issuance of money, and then a lot of capital. This concept is actually flow, which is the so-called money in the common people’s understanding.

But it’s not accurate, more money doesn’t mean more on a simple order of magnitude, it has an impact on assets that means the cost of money should be low enough, it actually means the cost of capital should be low. And this cost of capital is not just the nominal interest rate, let’s say the cost of borrowing, these things are called nominal interest rates, but it’s actually the real cost of capital generated by inflation expectations.

For example, if the implied inflation expectation is 2 percent, but the nominal interest rate is only 1 percent, the real cost of money is minus 1 percent. In other words, you will find that if inflation expectations are high, but very low nominal interest rates expected, actually will appear the situation of the real interest rate is negative, once appear negative, there will be a big problem, is all the assets will be typical valuation bubble, are short, you will see the assets are very high.

The Biden administration plans to raise the threshold for “made in America” purchases: 75% will be made in the United States.

Spark Global Limited reports:

The Biden administration on Wednesday released a fact sheet on the proposed “Buy American” rule. Under the biden administration’s new rules, it will propose further raising the bar for “American-made” purchases by the U.S. government.

Shortly after taking office in January, Biden signed an executive order on the Buy American Act, closing a loophole in the previous Act. The Buy American Act details about a third of the $600 billion the federal government spends on purchases each year. The current law requires a product to have 55% of its parts sourced in the United States before it can be purchased by the U.S. government.

Now the bar may be raised even higher.

According to an announcement on the White House website, the proposed rule guidance would further strengthen Buy American requirements in three ways:

① “Make Buy American Real” and close the loophole by raising the “made in America” ratio threshold.

The Buy American Act states that products purchased with taxpayer money must be “virtually all” made in the United States. At present, however, only 55 per cent (slightly more than half) of the components in a product are made in the US to qualify. The NPRM recommends raising the threshold to 60% immediately and to 75% in stages.

The proposal would close loopholes in existing regulations while also giving companies time to adjust their supply chains to increase the use of American-made components. If implemented, this change will create more opportunities for small and medium-sized manufacturers and their employees across the country, including small and vulnerable businesses.

② Strengthen the domestic supply chain of key commodities with new price concessions.

As has been reported since the outbreak, supply chain disruptions can affect the health, safety and livelihoods of Americans, depriving people of access to critical commodities during a crisis. Some goods are too critical to America’s national and economic security to rely on foreign imports.

The NPRM recommends that price offers be enhanced to include key products and components identified under the critical Supply chain review as defined in E.O. 14017 and the pandemic supply chain strategy as defined in E.O. 14001. Once in place, these incentives will support the development and expansion of domestic supply chains for key products by providing a steady source of demand for domestically produced products.

③ Increase transparency and accountability under the Buy American Rule.

For decades, inadequate reporting has impeded the implementation of “Buy American” rules. Currently, contractors can only tell the government if the threshold is met, rather than reporting the full domestic content of their products.

The NPRM recommends establishing specific reporting requirements for key products. The new reporting requirements could strengthen compliance with the Buy American Act and improve data on the actual U.S. made content of goods purchased. More complete and accurate data will be used for future improvements to support America’s entrepreneurs, farmers, ranchers and workers, and create good jobs and resilient communities in the process.

During a visit to a manufacturing plant in Pennsylvania on Wednesday, U.S. President Joe Biden also said the new rules would provide more effective support for domestic industry.

During a tour of a Mack Trucking plant, Biden pointed out:

“In recent years, ‘Buy American’ has become an empty promise. My administration will make ‘Buy American’ a reality.”

Biden also offered examples:

“The federal government owns about 600,000 vehicles that don’t have parts that can be made in the United States. The same is true for other goods that the government buys.”

Mr. Biden’s recent trip has been dominated by visits to manufacturing sites, and his team is now pushing for a bipartisan infrastructure package in Congress. The bill would spend $1 trillion on roads and Bridges, transportation projects — which would include railroads and airports, electric vehicle charging facilities, broadband service expansion, and improvements to water, sewer and power systems.

Speaking in Pennsylvania, Biden praised the progress made by lawmakers. He said:

“I’m working with Democrats and Republicans to get this done, because while we disagree on many issues, I believe we should be able to work together on the things we agree on.”

The Fed’s monetary policy follows the Taylor rule to the letter

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1. The main content of the July FOMC meeting

Policy decision: Maintain monetary policy, establish new repo facility. At the meeting, the Fed kept the federal funds rate unchanged at 0% to 0.25% and maintained the current pace of asset purchases. In addition, the Federal Reserve has set up permanent repo facilities SRF and FIMA respectively for domestic and foreign countries.

 

Meeting statement: further optimistic remarks on the economy. The meeting’s statement noted for the first time that “some progress has been made toward the goals of full employment and price stability, and this progress will continue to be reviewed in the future.”

Since last December, the federal reserve has been stated is to maintain its bonds at least $80 billion a month, at least $40 billion of MBS, until full employment and price stability target make substantive progress, and for the first time in the meeting pointed out that the goal set in December last year has made some progress, illustrates on the assessment of economic fundamentals, The Federal Reserve has begun to acknowledge real progress in the economy.

From the market’s immediate performance, after the meeting, the U.S. dollar and U.S. Treasury yields fell after a short-term rise, U.S. stocks and gold rose, assets reacted to the dovish, the reason may be that Powell’s speech in the press conference has not released more information on the Taper, The recent release of the Minutes of the June FOMC meeting and Powell’s remarks at the Congressional hearing also led to a dovish reaction in asset prices as they failed to deliver further tightening expectations.

However, we believe it is still not appropriate to underestimate the possibility of Taper release in August-September, given the current environment of monetary tightening in the U.S. economy and the lack of a change in direction from the Fed.

Why is the Fed introducing new tools that aren’t currently working?

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At the FOMC meeting in July, the Fed unveiled two new repo facilities, They are the Standing Repurchase Agreement Facility and the Standing FIMA Repurchase Agreement.

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If the word “Standing” is removed, the two tools will be familiar, and their function will be similar.

The minutes of the June meeting begin with a discussion of the feasibility, strengths and weaknesses of the two tools.

The reason I didn’t write too much about it at the time was that I didn’t think either of these tools would be introduced very quickly at this point in time, and I was very surprised to see these two new tools being introduced at the July conference.

The Fed accomplished this by providing temporary short-term liquidity (deposits) through repo transactions — purchases of securities — in the face of liquidity demands from various counterparties.

Note that in the Fed context, a repurchase facility is a liquidity facility and a reverse repurchase facility is a liquidity facility. The recent hot topic of overnight reverse repurchase is used to withdraw excess liquidity in the system, and the two new repurchase tools are both used to release liquidity.

Figure 1: Balance sheet when counterparty is primary dealer and SRF instrument is used

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Figure 2: The counterparty is the bank and the balance sheet when using the SRF facility

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Figure 3: Counterparties are the balance sheets of overseas central banks using the SFIMA facility

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What are SRF and SFIMA for?

As we can see from the balance sheet diagram above, the essence of the SRF and SFIMA instruments is to immediately convert a counterparty’s risk-free assets with a long duration into overnight liquidity, i.e., reserves/deposits, in a timely manner.

The parameters of the two tools are similar, with SRF at a $500 billion/day cap and SFIMA at a $60 billion/day cap for a single counterparty. By rough calculation, the Fed has the flexibility to pump more than $1 trillion of liquidity through its two tools.

Currently, SRF eligible collateral is US Treasuries, agency debt and MBS, while SFIMA eligible collateral is US Treasuries. The eligible collateral covered by both instruments is assets already held on the Fed’s balance-sheet.

In addition, the interest rates on both facilities are set at 25bps, the current top of the fed’s rate management range, flat with the primary credit rate at the discount window.

Why is it odd at this point to have these two tools on standby?

As mentioned above, I’m surprised to see both of these tools on stand-by at this point in time, starting with the repo market turmoil in 2019 and the FIMA launch at the end of March 2020.

SRF and SFIMA have three meanings for the Fed, but none of them are relevant to the market today. They are:

To permanently resolve the cash crunch, in response to historical events such as the repo market turmoil in late 2019 and the launch of FIMA during the pandemic crisis in March 2020.

Iterate its own interest rate management framework, introduce a new capped interest rate, enrich its own interest rate corridor.

Establishing itself as the central bank of the world to match the forthcoming us dollar digital currency (CBDC) credits.

First, with SRF, the Fed can avoid the repurchase wave that occurred in late 2019 because counterparties can always borrow from the Fed with TREASURIES and other eligible collateral.

In mid-September 2019, due to a sharp drop in reserves due to the corporate tax period, there was a significant transfer of reserves from the system to the TGA, while net Treasury issuance increased. Causing overnight money market rates in the US to soar and show significant volatility.

But that was against a backdrop of shrinking reserves and the Treasury’s appetite for cash, leaving less and less liquidity in the market for interest rates to break out of the Fed’s range.

The current situation is that the Fed has not yet started to taper QE, reserves are abundant and liquidity ($1 trillion) has poured into the overnight reverse repurchase facility (RRP). At one point in the first half of the year, money market rates were almost below zero.

Look at financial side, the market in August for the Treasury to refinance is expected to cut issuance, because the outbreak has gradually in the past, the fewer the fiscal spending, a spending bill size reduction will be a reduction, yellen also working to tax revenue, and therefore, the rebalancing of the fiscal deficit has makes Treasury of liquidity of the siphon effect weakened.

Isn’t it an inopportune time to provide a standing tool that can be called upon to create liquidity at any time during a flood of liquidity? Everyone has 5 BPS /10 BPS in their ONRPPs and reserve accounts, is anyone going to ask the Fed to borrow money for 25 BPS?

The same is true with the establishment of SFIMA. At present, the US Treasury market has not experienced the dramatic fluctuations of the outbreak, and the current use of US dollar liquidity swaps and FIMA is only a few hundred million dollars. To suddenly provide a single counterparty liquidity facility with a cap of $60bn would be too abrupt…

Yes, but you don’t have to.

Let’s talk about the second meaning.

The fed set the facility rate at 0.25%, the top of its current range.

And that makes sense, because in the previous framework of interest rate management, the Fed used the Floor System. Just to explain the system briefly.

The interest rate floor system, which provides a guaranteed rate for different market counterparties, allows the Fed to absorb funds on its balance-sheet through ONRRP (overnight reverse repurchase rate) in order to avoid excess liquidity in the market, where money has nowhere to invest.

For example, the current adjusted ONRRP is 5bps. Then the repo rate (SOFR) in the market would not fall below 5 BPS, because no fool would do that. Instead, he would put his money in ONRRP and eat 5 BPS.

In turn, the 25bps of SRF makes sense.

The SRF acts as an interest rate ceiling, meaning a ceiling rate for different market counterparties, because you can’t borrow at 30 basis points in the market when you can ask the Fed to borrow at 25 basis points.

SRF and SFIMA make it difficult for market rates to break the upper edge of their managed range, because counterparties can ask the Fed to create enough liquidity out of thin air at the upper cost. Unless the liquidity needs of the market exceed the upper limit of what SRF and SFIMA can provide.

ONRRP makes it harder for market rates to break the lower edge of the managed rate range, where counterparties can deposit enough liquidity. Unless excess liquidity in the market exceeds the upper limit for the use of ONRRP.

SRF and SFIMA did make the Fed’s rate-management framework more symmetrical.

In the event of a liquidity crisis in the banking system, banks can access liquidity through the Fed’s SRF and discount window facilities.

If dealers’ liquidity deteriorates due to overissuance, primary dealers can finance Treasury inventories at any time through the Fed’s SRF.

In case of a shortage of overseas dollar liquidity caused by an unexpected event, foreign central banks can convert their holdings of US treasuries into DOLLAR liquidity at any time through the FED’s SFIMA without selling.

SRF and SFIMA are necessary as part of the interest rate framework, but still seem a bit out of place at the moment.

Why is that? Because nobody wants money now… The control of the interest rate ceiling is usually considered during the period of tightening. Now even the Taper Taper has not started, and the rate increase and the contraction of the balance sheet are not in sight. Why the rush to SRF and SFIMA?

The third meaning is even less clear. It’s symbolic.

Overall, I think SRF and SFIMA are good tools and do enrich the Fed’s interest rate corridor system. But, at this point, few people will care.

In addition, there are some technical benefits associated with a potential overhaul of the monetary policy framework, but this may not work out if it continues to unfold.

In short, when you can turn long-dated assets into liquidity (reserves/deposits) at the Fed at any time, the need to hold reserves decreases. Then when it comes time to shrink the balance sheet, everyone will be less nervous, because banks and primary dealers can always expand their balance sheets through SRF.

If the Fed moves to the reserve-scarcity framework of the pre-2008 crisis, it is a different story.

The downside is that while the tools are being used, the Fed’s balance sheet is being passively expanded, and the most collateral is Us Treasuries, so there is a sense of being held hostage by the Treasury. But… Who says it’s not now?

SRF and SFIMA make no sense at this stage of the market and will not affect your asset allocation.

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