The FED Repo Operations, QE Programme, DXY, Gold and EURUSD
This is a shortened version of our April report.
Let us start with a summary:
The Fed announced Friday morning that it would purchase later in the day roughly half of some $80 billion in Treasury securities that it had said Thursday would be purchased over the next month.
Repurchase Agreement Operational Details
In accordance with the most recent Federal Open Market Committee (FOMC) directive, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York will conduct a series of overnight and term repurchase agreement operations (repos) to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation.
Securities eligible as collateral for both overnight and term operations include Treasury, agency debt, and agency mortgage-backed securities.
You can find the details of the operations: NYFED Domestic Market Operations
Let us keep one thing in our minds which would play an important role in Gold prices near term. This is a domestic market operation. If the FED limits the operation inside the US and keeps the liquidity domestic, Gold prices may remain under pressure.
Below the DXY/GOLD chart give us a similar view. In the 2008 crisis, Gold prices went down at the beginning of the crisis. Then a rally has started.
As I have mentioned in my previous report, the Global demand to Dollar will increase. ( I m referring to EUBSC .. or cross-currency basis swaps)
Few Details from Pozsar’s Covid and Global Dollar Funding Notes:
“What are some of the dynamics that could start pushing rates around in the repo and FX swap markets before too long?
There are at least three:
(1) U.S. banks gradually starting to pull back from lending in the repo market and starting to monetize Treasuries to fund the drawdown of corporate credit lines.
(2) Tech companies starting to monetize their bond portfolios to roll the lifeline they extended to their strategic suppliers in various corners of Southeast Asia.
(3) Foreign central banks starting to tap into their FX reserves to help local banks, and the pressures these flows might cause to repo and FX swap markets.”
The FED dislikes negative rates:
What markets are telling us is that the US Federal Reserve’s recent emergency 50 basis point rate cut and its decision to pump trillions of dollars into the financial system on Thursday have failed to do the trick. Further cuts in the policy rate, right down to almost zero, may also not be enough to stabilise the economy and return inflation to the 2 per cent target.
When the problem of the zero lower bound on rates first reared its head a decade ago, the major central banks initially thought rates could never go into negative territory, because this would induce a stampede out of bank deposits into notes and coin, which of course yield zero.
Former Fed chairman Ben Bernanke has suggested that negative policy rates in the US could be useful in some circumstances, but this has not seemed to persuade Mr Powell or current Federal Open Market Committee members.
Here are the three main reasons why.
First, it is not clear that the central bank is permitted under legislation to take this action, as Michael Feroli of JPMorgan and others have pointed out. The 2006 law that allows the Fed to pay interest directly to banks only says that depositors “may receive earnings” and does not contemplate the charging of fees. Some lawyers have interpreted this as ruling out negative rates. Congress could, of course, change the law, but the Fed is reluctant to ask for this, in case the ensuing political debate leads to demands for additional congressional oversight of rate decisions.
Second, the specific institutional features of the US financial system make it difficult to go negative. In particular, the existence of money market funds, which hold about $4tn in assets and are sometimes treated by depositors like bank accounts, could be a problem. Back in 2008, it caused enormous turmoil when one such fund “broke the buck” and was no longer able to protect investors’ principal. Although regulations for such funds have changed, the Fed still seems concerned that negative returns in these funds could cause panic in stressed market circumstances.
Third, and most important, the experience with negative policy rates in Japan and the eurozone does not provide conclusive evidence that such a dramatic change actually restores confidence and economic activity. Instead, there appears to be a “reversal” rate of interest. Below a certain point, really low negative rates not only do not stimulate the economy, they weigh it down.
This occurs because negative rates act like a tax on the banking system. Banks may respond by restricting credit rather than making the additional loans needed to get money out into the real economy. Although the evidence on these effects is mixed, the Fed certainly does not see a conclusive case for action.
Source: Article by Gavin Davies – published in Financial Times – Full Article
Here we have another issue: The real interest rates. This is an important determinant for Gold prices.
St Lois FED: Producer price index for final demand fell by the most in five years in February, declining a seasonally adjusted 0.6% after climbing 0.5% in January . See the details: PPI for Final Demand
If the US CPI declines due to coronavirus, the Dollars real interest rate may stay in the positive territory even if the FED cuts the rates on March 18th. This is a pressure for Gold prices.
Why the USD may remain stronger:
If policy rates stay close to zero for long periods, but never go negative, there would be important consequences for the likely future shape of the yield curve, the optimal mix of bonds and equities in investors’ portfolios, and the dollar. Several of these consequences have already become apparent in Japan.
While it is theoretically possible for bond yields to turn negative, even if policy rates are expected to remain in positive territory indefinitely, it seems unlikely that this could last for long. As John Maynard Keynes implied in his Treatise on Money in 1930, bond yields carry duration risk which normally should require a positive risk premium compared to cash. He thought there would be a “limiting point” on the minimum possible level for bond yields.
This remains true today, so bond yields would remain very low but positive if short rates stay close to zero. The implication is that long duration bond yields could fall no further and would no longer play any useful role in hedging equity risk in a balanced portfolio.
Another implication is that quantitative easing or other similar measures would no longer tend to reduce policy rates or bond yields, so may not send the dollar lower. In fact, in a risk-off situation where there is a flight to quality in global markets, the dollar would be likely to rise, even if the Fed is trying to ease monetary policy.
FT / Gavyn Davies
We drew attention to this issue at the beginning of March. DXY rally was inevitable.
What can happen next?
- It is not only the FED who pumps liquidity into the financial system. ECB, BoE, BoJ are hitting the record highs in their balance sheets.
We predict a new rally in DXY medium term.
The EURUSD pair is trying to hold 1.10400 support. Bearish move would be accelarated by the breakout of the support. 1.08800, 1.07400 and 1.05600 could be tested medium term.
On the downside, we see a strong support zone between 1479-1450. Potential bearish price actions can be used as a buying opportunity targeting 1700 and 1880 medium term.
FOMC Statement of March 18th would show us the path of the shorter term.
Global Indices? There will be times to buy. But sorry not now!!
Have a nice weekend.
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