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Speaker 1: Hello, and welcome to another episode of the Odd Thoughts Podcast.

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Speaker 1: I'm Tracy Allawitt and I'm Joe. Joe. What was the

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Speaker 1: biggest thing that happened in markets in recent months over

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Speaker 1: the summer. It's like a test. I think it's like

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Speaker 1: a test of, you know, what people are looking at

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Speaker 1: the moment, what they find interesting. I mean, the FED tightening. Obviously, yes,

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Speaker 1: this is the correct answer. Okay, I'll stop there. I

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Speaker 1: got it right, So I'm just gonna stop there and

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Speaker 1: you can go on. Okay, So the FED started quantitative tightening.

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Speaker 1: We're recording this in late June, and weirdly, it kind

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Speaker 1: of went by without that much fanfare, Like there were

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Speaker 1: a few news articles about the FED firing the starting

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Speaker 1: gun on quantitative tightening and the unwind of its very

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Speaker 1: very large balance sheet, but there was so much going

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Speaker 1: on at the same time, you know, there was that

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Speaker 1: surprise seventy five basis point interest rate hike, and then

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Speaker 1: lots of talk about inflation and things like that that

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Speaker 1: it feels like it didn't get as much attention as

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Speaker 1: it probably should have. Most of the attention is paid

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Speaker 1: to the rate obviously, you know, queue when it was

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Speaker 1: first unveiled or when Ben Berneki did QUI two, which

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Speaker 1: was the real QUEI during the Great financial crazies, I

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Speaker 1: got so much attention, but there still seems to be

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Speaker 1: a lot of ambiguity about a how it works, what

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Speaker 1: it does, what it accomplishes, and then in terms of

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Speaker 1: like the degree to which unwinding the balance sheet is

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Speaker 1: or is not an additional form of policy, tightening is

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Speaker 1: something that I just feel like is at best, like

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Speaker 1: still deeply misunderstood. It is kind of crazy that even

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Speaker 1: after years and years of quantitative easing, there's still a

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Speaker 1: discussion about what the impact is and how it actually works.

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Speaker 1: I mean, I remember people still arguing about whether or

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Speaker 1: not it pushes up asset prices and things like that.

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Speaker 1: And there are people out there right now who are

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Speaker 1: arguing that the reason markets have fallen might not actually

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Speaker 1: have to do that much with inflation concerns and worries

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Speaker 1: over a looming recession, but could just be because liquidity

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Speaker 1: is starting to exit the system. No, No, I mean,

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Speaker 1: it's totally it's totally valid. You know, it's worth noting

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Speaker 1: that we have had, you know, markets boomed even though

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Speaker 1: there was no longer a further expansion of the balance sheet.

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Speaker 1: You know, we started to rally in early nineteen again

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Speaker 1: even as the balance sheet shrank for a while, going

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Speaker 1: into some of the tensions, but it really is wild,

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Speaker 1: as you say, like how little we know and how

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Speaker 1: little even I mean, I think even the FED knows

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Speaker 1: about like quanted measuring the effects of changes to the

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Speaker 1: size of the balance sheet. Well, there is also an

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Speaker 1: argument to be made that the QUEI that we seen

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Speaker 1: over the past couple of years is stylistically and quantitatively

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Speaker 1: different than the ones we've seen prior, and so the

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Speaker 1: exit is going to be different too. So we are

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Speaker 1: going to dig into all of these um very big

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Speaker 1: and technical questions and I'm happy to say we really

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Speaker 1: do have the perfect person to discuss this. We're going

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Speaker 1: to be speaking with someone who's been on the podcast before, Joe,

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Speaker 1: but I think you were actually away for that effort. Yeah,

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Speaker 1: so I'm thrilled to have him back. We're going to

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Speaker 1: be speaking with Joseph Wang. He used to work at

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Speaker 1: the New York Fed on the Open Markets desk, conducting

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Speaker 1: repo operations, basically being deep in the weeds of money markets,

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Speaker 1: and now he runs a blog called fed Guy, which

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Speaker 1: is really a must read if you're interested in monetary

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Speaker 1: policy and in all of these big questions about how

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Speaker 1: it actually works. So, Joseph, thank you so much for

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Speaker 1: coming back on ad thoughts. Tracy, Hey, Joe, thanks so

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Speaker 1: much for your biding. Yet it's a pleasure to be here. Yeah,

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Speaker 1: So maybe just to begin with, could you give us

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Speaker 1: the bra outline of how quantitative tightening or the QUEI

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Speaker 1: that we've seen over the past couple of years. You know,

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Speaker 1: as I alluded to, it's different to the QUI that

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Speaker 1: we've seen in the past. So I guess the question

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Speaker 1: is how different is it this time? Like? What makes

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Speaker 1: this particular exit different to previous periods of quantitative tightening

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Speaker 1: that we've seen. Sure, so I think this time QUT

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Speaker 1: is a different first and the level, and I think

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Speaker 1: there's changes in the financial in the structure of the

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Speaker 1: financial system that make a bit more difficult. So this

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Speaker 1: time around, QUI looks like it's going to ramp up

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Speaker 1: to about nine billion dollars a month now. In contrast,

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Speaker 1: the last time around when we did this, the maximum

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Speaker 1: that we ever did was fifty billion dollars a month.

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Speaker 1: So in terms of pace, it's a much much more

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Speaker 1: aggress pace. We're doing nine billion a month, can kind

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Speaker 1: of contrast last time the maximum we did was fifty

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Speaker 1: billion a month. So the way that this works through

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Speaker 1: the system, I think Bradley speaking, I think of QT

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Speaker 1: as having two mechanisms. One is that it increases the

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Speaker 1: supply of treasuries into the market. That's one, and that's

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Speaker 1: kind of how the FET thinks of it. It. By

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Speaker 1: increasing or increasing the supply of treasuries, you are pushing

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Speaker 1: the term premium higher, so it puts upward pressure on

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Speaker 1: interest rates. And the second mechanism has to do with

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Speaker 1: draining liquidity out of the system. So these two mechanisms

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Speaker 1: are related but also operate in separate ways, And they

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Speaker 1: also have a lot of moving parts into how they

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Speaker 1: actually can play out. And these moving parts aren't completely

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Speaker 1: within the FET's control. So because of this, QT can

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Speaker 1: play out in a range of outcomes. You can have

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Speaker 1: very benign QT, where it really is just washing paint

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Speaker 1: dry as Railie and what mentioned before, or you can

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Speaker 1: have QT that's more aggressive and very disruptive. Now, based

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Speaker 1: on what I see in the current configuration of the

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Speaker 1: financial system, considers so many moving parts, it seems what's

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Speaker 1: happening right now is compared to last time, QT, this

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Speaker 1: time is going to be a lot more disruptive. I

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Speaker 1: guess I can talk about why from the So I'll

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Speaker 1: go by the first mechanism, the increase in trgury supply,

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Speaker 1: and then I'll talk about why draining liquidy this time

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Speaker 1: will also be more disruptive. So when QT increases the

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Speaker 1: supply of treasuries into the private sector, the Fed doesn't

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Speaker 1: actually get to decide what tenors that reach the market.

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Speaker 1: That's a decision by the U S. Tresury techne. Overall,

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Speaker 1: what happens is that um when the feed is doing QT,

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Speaker 1: it's it's receiving repayments for the tresury that it owes

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Speaker 1: that that it owns. So the U S Trsury issues

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Speaker 1: new debt and takes that money and repays the ft.

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Speaker 1: That's what happens. So it's the U S. Treasury that

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Speaker 1: gets decide what are the new what are the tenors

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Speaker 1: of the new treasuries that the market absorbs. Now, you

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Speaker 1: can do this in a way that's very market neutral.

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Speaker 1: So let's say the U S. Tregury issues a lot

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Speaker 1: of short data debt, Treasury builds now, the market can

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Speaker 1: absorb these treasury bills very easily. If you think back

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Speaker 1: to the first quarter of the tresury issued two trillion

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Speaker 1: dollars in bills in the market just lapped that up easily.

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Speaker 1: So in a sense, it's because bills are so cash like,

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Speaker 1: it's they don't really have any interest rate impact. But

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Speaker 1: what the U. S. Treasury is doing this time around,

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Speaker 1: it's actually cutting bill issuance, so because it had received

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Speaker 1: a lot of tax payments in April above its expectations.

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Speaker 1: So all the q T increase in supply over the

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Speaker 1: next few months is going to be in coupons, and

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Speaker 1: coupons are more difficult for the market to absorb, so

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Speaker 1: it's probably going to place more upward pressure on interest rates.

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Speaker 1: There are also a lot more mechanics behind this that

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Speaker 1: that make it the same around more disruptive. So, for example,

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Speaker 1: we're having a big change in who the Marshall wires

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Speaker 1: are in this market. Well, actually, I'll sit back a

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Speaker 1: bit and say, so the increases imply this time around

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Speaker 1: is much higher than it was last time around. I

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Speaker 1: think it's useful to think about treasury rates in terms

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Speaker 1: of supply and demand. So in terms of supply, the

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Speaker 1: sime around the amount. Taking into account of QT the

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Speaker 1: estimates for the increase in supply to the private sector,

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Speaker 1: it's going to be about one point five trillion dollars

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Speaker 1: a year, so for the next three years. Now, just

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Speaker 1: for context, pre COVID, the amount of supply that was

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Speaker 1: going into the market was about five dred billion dollars

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Speaker 1: a year, and so the pace of the supply is

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Speaker 1: just so so much higher than than it was the

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Speaker 1: last time we did this. And that is happening in

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Speaker 1: the context of from the say demand side, from the

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Speaker 1: buyer side, where the Marshall buyer is changing and the

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Speaker 1: market structure doesn't seem very strong. The Marshall buyer for

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Speaker 1: treasuries before COVID was actually the hedge fund the hedge funds.

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Speaker 1: So what the hedgemunds were doing they were buying let's say,

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Speaker 1: hundreds of boons haves and treasuries several hundred billions and treasuries,

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Speaker 1: but they were buying it as part of a basis trade,

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Speaker 1: so they actually didn't really care about things like growth

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Speaker 1: and inflation. It was really about the spread between the

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Speaker 1: cast treasuries in the future. So there were the marginal buyers.

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Speaker 1: Post COVID, it was all about the FED and the

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Speaker 1: commercial banks. The commercial banks, because of regulation, they have

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Speaker 1: to own a lot of liquid assets and they were

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Speaker 1: buying tremendously. So those players are not in the market anymore.

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Speaker 1: And there were also players who are much more agnostic

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Speaker 1: to things like where the interest rates were because they

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Speaker 1: have to buy them as part of a pair's trade

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Speaker 1: or for regulation. Those people are out, and you're having

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Speaker 1: to a situation where we're looking for the new Marshal buyer,

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Speaker 1: and that new Marshall buyer is probably going to be

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Speaker 1: more sensitive to things like inflation rates. And you know

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Speaker 1: as well as we see and this happening in UH inflation,

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Speaker 1: it's it's not clear what that is, nor what defense

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Speaker 1: policy rate will be going forward, So there's gonna be

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Speaker 1: some volatility there. M And one more thing, and you

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Speaker 1: can see chair Power and mentioned this again, Trojery market

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Speaker 1: liquidity is not pretty good. So when we have this

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Speaker 1: tremendous increase in supply changing demand amidst very low Tridrey

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Speaker 1: market liquidity. So just just for some context, so every

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Speaker 1: day in the trojury market, we do about six hundred

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Speaker 1: billion dollars in cash cash transactions, and we have about

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Speaker 1: a twenty three trillion dollar trojury market for the private sector.

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Speaker 1: So if you rewind the clock twenty years ago, we

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Speaker 1: had about seven trillion dollars in net market. About treasuries

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Speaker 1: daily volumes are about four hundred billion, So today the

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Speaker 1: total treasuries volumes have more than triple toe trillion, but

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Speaker 1: the liquidity daily liquidity is only a little bit higher,

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Speaker 1: from four hundred billion to six hundred billion, So you

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Speaker 1: can have in a sense, you can think about let's

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Speaker 1: say the stadium getting a lot bigger, but the doors

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Speaker 1: are not really increasing, and that's a big reason why

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Speaker 1: we see these huge moves and treasury utes recently. I

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Speaker 1: think a few weeks ago, we sell the tenure, just

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Speaker 1: jump twenty five basis points, we sell the treasury market

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Speaker 1: break in March, and we've had flash crashes in the past,

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Speaker 1: so it's kind of there's this storm brewing from my perspective,

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Speaker 1: where you have enormous issuance, you have a weak market structure,

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Speaker 1: and you also have a demand side for treasuries that

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Speaker 1: that's becoming a little uncertain. So uh, that's just with

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Speaker 1: the treasury please no, So I want to explore like

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Speaker 1: the liquidity side a little bit more. And one of

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Speaker 1: the things that we talked about in a recent episode.

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Speaker 1: You know, like treasuries and reserves are not that different

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Speaker 1: from a sort of like economic perspective, Right, So, Okay,

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Speaker 1: you talk about there's a huge increase into the market

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Speaker 1: of these treasuries that the FED will be getting rid

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Speaker 1: of reducing, but on the other hand, it's also diminishing

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Speaker 1: the reserves the liability side of the balance sheet, and

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Speaker 1: so on some level there's an evenness to it. And

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Speaker 1: economically they're not radically different, they are somewhat different. Explain

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Speaker 1: further the effect on liquidity from swapping two assets that

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Speaker 1: are not that different. Yeah, that's a really good question.

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Speaker 1: So I think there's a couple of things to this.

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Speaker 1: One is that reserves can only be held by commercial banks,

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Speaker 1: so occurrence, So reserves are basically deposits at the FED,

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Speaker 1: and only commercial banks probably speaking, can have deposits at

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Speaker 1: the at the FED. So from a commercial banks standpoint, Joe,

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Speaker 1: you're you're right, it's it's very equivalent. I mean, there's

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Speaker 1: more interest rate risk in a treasury, for example, but

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Speaker 1: for a commercial banks standpoint, I can have reserves in

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Speaker 1: my liquidity portfolio, or I can have treasuries. And what

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Speaker 1: they've been doing for the past couple of years is

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Speaker 1: they're making that choice to say that I want to

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Speaker 1: have treasuries rather than reserves, since treasuries are using much

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Speaker 1: more than interest on reserves. But that's not the decision

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Speaker 1: faced by people who are not banks. So for example,

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Speaker 1: you and me, we have deposits at a commercial bank.

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Speaker 1: We don't we're not eligible to hold reserves at the FED.

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Speaker 1: So when the FED is doing QT, from from our perspective,

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Speaker 1: the deposits in the system are declining. So when the

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Speaker 1: FED does QT, it reduces reserve assets at commercial bank

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Speaker 1: which are often backed by deposit liabilities. So it's this

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Speaker 1: two tiered monetary system we have where non banks have

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Speaker 1: deposits at banks and banks sold deposits at the FED.

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Speaker 1: So from our perspective, we're losing bank deposits, which are

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Speaker 1: you know, carry credit risk and don't earn idle R.

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Speaker 1: So the substitution is it's not perfect. But I think

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Speaker 1: more broadly, the point though, is it seems like right

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Speaker 1: now what's happening is that treasury start becoming less cash.

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Speaker 1: Like you can see this in the lack of flight

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Speaker 1: to safety in market volatility, bonds are selling off and

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Speaker 1: stocks are selling off. So when we have high inflation

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Speaker 1: and we have a lot of rate volatility, it seems

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Speaker 1: like the market is not rushing to treasuries as safety.

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Speaker 1: They're rushing through just cash. And so that that makes

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Speaker 1: it I think this asset swap that that you talked about,

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Speaker 1: which is broadly what QUE is not as perfect substitutes

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Speaker 1: for each other. So I just want to touch on

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Speaker 1: on one consequence of the dynamic you just described before

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Speaker 1: we go more into q T and the mechanics there.

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Speaker 1: But we've spoken about this before, I think last year,

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Speaker 1: but the implication that banks aren't necessarily buying treasuries but

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Speaker 1: because they think that, you know, interest rates are going

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Speaker 1: to go up or down, but they're buying them because

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Speaker 1: they have to buy treasuries to satisfy liquidity coverage ratios

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Speaker 1: and regulatory requirements and things like that, and treasuries are

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Speaker 1: sort of the best option of the assets that are

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Speaker 1: available to do that. So what does that actually mean

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Speaker 1: when it comes to treasury yields? Like when we look

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Speaker 1: at a treasury yield, now, how much information is that

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Speaker 1: actually giving us about investors, expectations for the future direction

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Speaker 1: of the economy and things like that. When I look

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Speaker 1: at tragedy yields, I don't actually think there's a lot

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Speaker 1: of information content. And I don't think so because as

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Speaker 1: you as you know to Treasury Tracy, there's a lot

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Speaker 1: of people who buy treasuries for different reasons. So you

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Speaker 1: do have investors who, let's say, look at growth and

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Speaker 1: inflation and look at yields and make a judgment. But

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Speaker 1: treasuries are very special in the financial system and that

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Speaker 1: they are considered a high quality asset, a credit risk

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Speaker 1: free asset, and under a range of regulations people have

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Speaker 1: to buy them just because the regulations tell them too.

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Speaker 1: And banks, for example, they have to hold high quality

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Speaker 1: liquid assets, as you mentioned, under things like the liquidity

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Speaker 1: coverage ratio. What qualifies as high quality looquoid assets a

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Speaker 1: very very narrow range of assets, treasuries being one of them,

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Speaker 1: and so they have to buy some of that. But

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Speaker 1: it's not just them. Um, if you look at let's say,

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Speaker 1: government sponsored emprises like Fannie may or Freddie Mac, they

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Speaker 1: also have similar regulations that they have to buy high

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Speaker 1: quality liquid assets. Or if you look abroad, if you

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Speaker 1: are a foreign reserve manager, if you're managing the foreign

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Speaker 1: reserves of let's say Japan or China or some other countries,

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Speaker 1: you can't really buy just equities or anything like that.

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Speaker 1: You usually other than the substational make usually you're very

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Speaker 1: very conservative, and so you can only buy things like treasuries.

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Speaker 1: So there's a there's a lot of demand for treasuries

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Speaker 1: that that's just not that UH driven by fundamentals. And

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Speaker 1: of course you can have hedge funds who are just

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Speaker 1: buying it as part of a basis trade where they

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Speaker 1: care about the spread between the trusuries and something else

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Speaker 1: rather than the absolute level of the trusuries as measured

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Speaker 1: by UH. It's the economic fundamentals. So it's it's really

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Speaker 1: hard to to look at from my perspective, to look

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Speaker 1: at price and infer economic conditions. So thinking about, you know,

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Speaker 1: in terms of like the mechanics or the implications of

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Speaker 1: quantitative tightening, why don't we start off with a sort

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Speaker 1: of kind of basic question. But it's like, why does

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Speaker 1: the Fed feel an impulse to reduce the size of

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Speaker 1: its balance sheet because it has the rate channel it

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Speaker 1: can hike rate it has it's been hiking fairly aggressively

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Speaker 1: seventy seventy five at the last meeting. Where does the

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Speaker 1: urgency or just even the impulse come from to decreased holdings?

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Speaker 1: I think from the FETs perspective, it's it's a lot

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Speaker 1: like you and Tracy suggested earlier in the show, the

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Speaker 1: FETE doesn't really understand what exactly happens, and so they

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Speaker 1: want to do with something that they understand they think

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Speaker 1: they understand well, like the overnight rate. So it seems

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Speaker 1: from what I hear, they want to get out of

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Speaker 1: this Balanciet stuff and go to something that they feel

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Speaker 1: like they're more comfortable with, which is raising the over

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Speaker 1: night rate. And you know, as you said, as you mentioned,

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Speaker 1: you have disagreements within the FED as to what exactly

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Speaker 1: QUI does. How you have people who would be like, oh,

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Speaker 1: you know, he doesn't really do anything, just solving one

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Speaker 1: asked for another. And you have people in the market

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Speaker 1: who look at KUI and just max long because QWI

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Speaker 1: makes the market go higher. So I think there's a

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Speaker 1: there's just not very clear what it actually does, and

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Speaker 1: they don't want to be doing things that they don't

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Speaker 1: really understand. What do you think it does? Can you

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Speaker 1: sort of describe for us what draining liquidity would look

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Speaker 1: like in the current period versus draining liquidity from say

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Speaker 1: or nineteen, because I think that might help us sort

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Speaker 1: of understand the differences here and the difference in the mechanism. Sure,

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Speaker 1: so when the FED drains liquidity out of the financial system,

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Speaker 1: it doesn't actually have control where the liquidity comes out of.

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Speaker 1: It can come out of the banking system, which you

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Speaker 1: would drain reserves and deposits, or it can come out

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Speaker 1: of the RAP, which which just decrease the RAP size.

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Speaker 1: Now the RAP, as you see right now, it's very large.

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Speaker 1: It's two two point two trillion. The the RP you

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Speaker 1: can think of as just the true excess liquidity in

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Speaker 1: the final nancial system. There's all this money that people

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Speaker 1: have nowhere else to invest in, and so they just

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Speaker 1: leave it on deposit at the FED at the end

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Speaker 1: received the IRP rate. So when you do q T,

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Speaker 1: if money is coming out of the IRP, you're it's

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Speaker 1: going to be a very benign because you're taking money

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Speaker 1: out that really nobody wants, or you could take it

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Speaker 1: out of the banking system, which conceivably someone somewhere is

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Speaker 1: reliant upon that that that liquidity. The FED beforehand doesn't

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Speaker 1: actually know what will happen if you listen to fit

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Speaker 1: precedents tak over the past few months. They just look

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Speaker 1: at the RAP and they think that there's a lot

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Speaker 1: of excess liquidity in the system, and so they can

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Speaker 1: they can we can just do aggressive QT, no problem.

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Speaker 1: But if you notice what's happening right now is that

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Speaker 1: the RP is not declining, it will probably go much

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Speaker 1: higher in my view, right so I have to say,

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Speaker 1: we're recording this right before quarter end, so right before

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Speaker 1: the end of June, and there is a very high

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Speaker 1: chance that it could shoot up. I think in May

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Speaker 1: it went above something like two trillion dollars, which was

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Speaker 1: a record at the time, but we could get another

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Speaker 1: record before this episode actually publishes. Yeah, when I used

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Speaker 1: to round the rap, we were very surprised for like

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Speaker 1: five billion. Now that that's that's too low. Um, what happens.

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Speaker 1: So the reason is that you have all this liquidity. Um,

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Speaker 1: how it gets strained ultimately depends on who buys the

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Speaker 1: newly issued treasuries and how they finance it. If the

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Speaker 1: treasuries are purchased by people who are levered investors, then

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Speaker 1: a drain it's the RP. For example, if you are

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Speaker 1: a hedge fund and you buy the newly issued our

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Speaker 1: treasuries with repo loan, then the cash from that repole

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Speaker 1: loan ultimately comes from the RAP. A money market fund

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Speaker 1: will withdraw money from the RP and lend it in

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Speaker 1: repo to the hedge fund investor. Money fund investors can

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Speaker 1: only lend, can only make specific investments, very narrow one

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Speaker 1: of them is repo, so that's basically the only that

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Speaker 1: in increased bill issuance, but broadly speaking, that would be

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Speaker 1: how you get the RP lower. On the other hand,

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Speaker 1: if the people who buy the newly issue treasuries are

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Speaker 1: let's say cash investors who are buying it with deposits

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Speaker 1: they held out commercial banks, then what you will see

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Speaker 1: is that liquidity will be drained out of the banking system.

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Speaker 1: So that means that what's being drained is not necessarily

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Speaker 1: liquidity that's held in the RAP that no one wants

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Speaker 1: that's access, but liquidity in the banking system that maybe

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Speaker 1: someone somewhere is relying on. Now beforehand, it's hard to

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Speaker 1: see where the where the liquidity will be drained, but

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Speaker 1: the way that I look at this is I just

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Speaker 1: look at what's actually been happening the past few months.

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Speaker 1: So the past few months, when the Treasury has been

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Speaker 1: issuing coupon debt, the people who have been buying it

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Speaker 1: have been people who are holding money at a commercial bank.

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Speaker 1: So you can see that what the increases over the

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Speaker 1: past few months, the amount of reserves in the commercial

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Speaker 1: banking system is declining, but the amount of in the

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Speaker 1: RP is not declining. So just how the financial system

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Speaker 1: is currently configured that there doesn't seem like there's going

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Speaker 1: to be any increased demand for leverage treasury investing. So

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Speaker 1: going forward, what you can actually see is that the

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Speaker 1: draining from QT comes out of the commercial banking system,

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Speaker 1: whereas the RAP continues to increase. This, in a sense,

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Speaker 1: is kind of like a double tightening effect because when

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Speaker 1: the RAP goes higher, it's also draining liquidity out of

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Speaker 1: the banking system. So this is why it seems on

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Speaker 1: this side of the equation. From my perspective, draining liquidity

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Speaker 1: can also be disruptive. You're not draining liquidity out of

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Speaker 1: the RAP, which would be painless for the financial system,

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Speaker 1: You're draining it out of the banking system, and the

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Speaker 1: RAP is also suching liquidity out of the banking system.

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Speaker 1: Let me ask you another kind of slightly bigger picture question,

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Speaker 1: But you talked about the balance sheet remains a tool

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Speaker 1: that the FED is, you know, it's hard to quantify

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Speaker 1: its effects, perhaps it's a little bit uncomfortable using it

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Speaker 1: and so forth. And it seems to me that you know,

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Speaker 1: you're thinking about the difference between post Grade Financial Crisis

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Speaker 1: and post COVID that QUEI was sort of used differently,

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Speaker 1: and so post Great Financial Crisis, the FED it to

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Speaker 1: hit the zero lower bound and felt it needed to

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Speaker 1: ease further, and so it brought assets, whereas my sense

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Speaker 1: of sort of march was that there was a big

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Speaker 1: l and specifically of this liquidity effect and of this

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Speaker 1: uh you know, wanting to sort of credit easing and

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Speaker 1: backstop credit market specifically via asset purchases. I guess you know,

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Speaker 1: the question I've wondered is did they sort of backdoor

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Speaker 1: themselves into using a tool that it actually never really

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Speaker 1: wanted that because it had this unusual situation, they didn't

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Speaker 1: really want to have to go back to QUEI, but

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Speaker 1: they sort of were forced to. And it's stuck around

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Speaker 1: longer because they had this sort of different need when

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Speaker 1: COVID hit, I think you're you're right that they used

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Speaker 1: to QUEI differently in COVID. So POSTDFC, it was largely

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Speaker 1: used as a tool to lower longer dated interest rates.

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Speaker 1: So the Fed hit the zero bound, they wanted to

430
00:24:45,720 --> 00:24:48,399
Speaker 1: continue to ease by putting downward pressure on longer date

431
00:24:48,480 --> 00:24:50,640
Speaker 1: interest rates. So in order to do that, it bought

432
00:24:50,680 --> 00:24:54,879
Speaker 1: a lot of treasuries now tasks for to March, it

433
00:24:54,960 --> 00:24:57,600
Speaker 1: was a little bit different because the treasury market broke.

434
00:24:58,320 --> 00:25:01,359
Speaker 1: So what that meant was that people who wanted to

435
00:25:01,920 --> 00:25:05,639
Speaker 1: sell their shoulders for cash cannot do that. So on

436
00:25:05,680 --> 00:25:08,720
Speaker 1: a global scale, treasuries are kind of where people keep

437
00:25:08,760 --> 00:25:11,560
Speaker 1: their dollars. It's kind of like a huge bank, so

438
00:25:11,600 --> 00:25:14,159
Speaker 1: to speak. So for example, if you and I we

439
00:25:14,359 --> 00:25:15,840
Speaker 1: go to the bank and we want to get our

440
00:25:15,880 --> 00:25:18,520
Speaker 1: cash out because we need cash, we expect to be

441
00:25:18,600 --> 00:25:21,080
Speaker 1: able to get that. But if the bank says, sorry,

442
00:25:21,119 --> 00:25:23,560
Speaker 1: I don't have any cash, then you know, we panic.

443
00:25:23,640 --> 00:25:25,840
Speaker 1: There's a there's a run on that bank. And that's

444
00:25:25,880 --> 00:25:29,600
Speaker 1: what happened in March. The trosury market. Everyone wanted to

445
00:25:29,640 --> 00:25:32,159
Speaker 1: sell their trogrees for cash, realized that they could not

446
00:25:32,320 --> 00:25:34,520
Speaker 1: actually sell their trajury for cash. In a sense, there

447
00:25:34,560 --> 00:25:36,359
Speaker 1: was a run on the market, and they started selling

448
00:25:36,400 --> 00:25:39,560
Speaker 1: everything else they could to get cash. The FEDS saw that,

449
00:25:40,080 --> 00:25:44,480
Speaker 1: and they wanted to help that by basically backstoppying the

450
00:25:44,520 --> 00:25:47,480
Speaker 1: troldan market, becoming a liquidity privator of last resort, and

451
00:25:47,520 --> 00:25:50,040
Speaker 1: they purchased let's say, about trillion dollars of tresuries in

452
00:25:50,080 --> 00:25:54,560
Speaker 1: one month. That's how KEE came back in. But it

453
00:25:54,680 --> 00:26:00,400
Speaker 1: stayed far, far far beyond uh, the liquidity event at

454
00:26:00,440 --> 00:26:03,600
Speaker 1: that stage. I think it morphed back into easing financial

455
00:26:03,640 --> 00:26:06,239
Speaker 1: conditions as you suggested, which I take to meet the

456
00:26:06,280 --> 00:26:10,000
Speaker 1: original QUWI motivation of putting down red pressure on interest rates.

457
00:26:10,560 --> 00:26:13,359
Speaker 1: So that's how I think about that. I agree it

458
00:26:13,400 --> 00:26:16,680
Speaker 1: probably was not super necessary after after for the length

459
00:26:16,680 --> 00:26:20,000
Speaker 1: of time that they kept it. You know, you mentioned

460
00:26:20,400 --> 00:26:23,919
Speaker 1: the treasury market blow up in and again this is

461
00:26:23,960 --> 00:26:26,040
Speaker 1: something that we've been talking about quite a lot recently

462
00:26:26,080 --> 00:26:29,000
Speaker 1: on other episodes. We also had the repo blow up

463
00:26:29,040 --> 00:26:32,680
Speaker 1: from and I think the response to that was the

464
00:26:32,760 --> 00:26:36,280
Speaker 1: creation of the Standing Repo Facility the s r F,

465
00:26:36,720 --> 00:26:40,919
Speaker 1: which basically allowed banks to exchange treasuries for dollars, And

466
00:26:40,960 --> 00:26:44,600
Speaker 1: so I'm wondering, does the existence of something like that

467
00:26:45,000 --> 00:26:47,639
Speaker 1: doesn't make it less possible that we're going to get

468
00:26:47,720 --> 00:26:50,560
Speaker 1: some sort of major blow up or are there limits

469
00:26:50,560 --> 00:26:53,440
Speaker 1: to what the SRF can do in the current environment.

470
00:26:54,800 --> 00:26:58,720
Speaker 1: So last time around, QT basically contributed to the blow

471
00:26:58,800 --> 00:27:01,679
Speaker 1: up of the report market, as you noted. So I

472
00:27:01,720 --> 00:27:04,080
Speaker 1: don't I don't think that's going to happen this sun around.

473
00:27:04,119 --> 00:27:06,320
Speaker 1: But so I mean, we we never have the same

474
00:27:06,359 --> 00:27:08,960
Speaker 1: thing blow up. Usually I think stress will be in

475
00:27:09,040 --> 00:27:11,919
Speaker 1: somewhere else. And I think too to understand why I

476
00:27:11,920 --> 00:27:14,280
Speaker 1: think the stress would be somewhere else, it's helpful to

477
00:27:14,320 --> 00:27:17,399
Speaker 1: revisit what actually happened. Why did QT caused the report

478
00:27:17,440 --> 00:27:23,400
Speaker 1: market to blow up? In for some context, in twenty UM,

479
00:27:23,400 --> 00:27:27,000
Speaker 1: heading into let's say, say September, when the report market

480
00:27:27,000 --> 00:27:30,280
Speaker 1: blew up, there was a tremendous demand for report financing.

481
00:27:30,520 --> 00:27:33,840
Speaker 1: The amount of repot demand for report financing increased by

482
00:27:33,880 --> 00:27:36,240
Speaker 1: a few hundred billion in the in the months leading

483
00:27:36,280 --> 00:27:38,240
Speaker 1: up to September twenty nineteen. And those are all the

484
00:27:38,240 --> 00:27:42,680
Speaker 1: hedge funds doing the doing their basis trades, and that

485
00:27:42,720 --> 00:27:48,040
Speaker 1: pushed report rates um steadily higher and ultimately above interest

486
00:27:48,119 --> 00:27:52,959
Speaker 1: on reserves. So the banks saw the saw that report

487
00:27:53,000 --> 00:27:57,560
Speaker 1: rates were above interest on reserves, and they note that

488
00:27:57,880 --> 00:28:01,399
Speaker 1: lending in treasury back repo from a regulatory standpoint, is

489
00:28:01,480 --> 00:28:04,399
Speaker 1: equivalent to holding reserves at the FED. So they figured

490
00:28:04,480 --> 00:28:07,800
Speaker 1: that they can earn some extra return by shifting the

491
00:28:07,840 --> 00:28:12,120
Speaker 1: composition of their liquidity portfolio to fewer reserves and more

492
00:28:12,160 --> 00:28:16,919
Speaker 1: repot and so heading into September, the banks became the

493
00:28:17,000 --> 00:28:19,639
Speaker 1: marginal lender in the report market to the tune of

494
00:28:19,720 --> 00:28:24,159
Speaker 1: hundreds of billions of dollars. So QT was playing in

495
00:28:24,160 --> 00:28:27,240
Speaker 1: the background, and what QT was doing it was withdrawing

496
00:28:27,320 --> 00:28:31,080
Speaker 1: the amount of UH excess cash the banks out the reserves.

497
00:28:31,440 --> 00:28:34,960
Speaker 1: So as we had from a demand side, continued demand

498
00:28:35,000 --> 00:28:38,600
Speaker 1: for report financing, and on the supply side, thanks being

499
00:28:38,600 --> 00:28:41,280
Speaker 1: the marginal lenders in the market, their extra cash bell

500
00:28:41,400 --> 00:28:45,080
Speaker 1: declining because of QT. Eventually the market hid an air

501
00:28:45,120 --> 00:28:50,240
Speaker 1: pocket where report rates spiked higher uncontrollably. Another way to

502
00:28:50,280 --> 00:28:53,120
Speaker 1: think about this is that the markets that benefited from

503
00:28:53,560 --> 00:28:57,640
Speaker 1: KWI cash were hurt by QT and the major beneficiary

504
00:28:57,720 --> 00:29:00,840
Speaker 1: in QWI cash last time around, as report we don't

505
00:29:00,880 --> 00:29:03,600
Speaker 1: have that problem at all. The sign because report rates

506
00:29:03,640 --> 00:29:06,840
Speaker 1: are much lower than io R. Banks are not lending

507
00:29:06,880 --> 00:29:10,480
Speaker 1: in report. What they have been lending in, as I

508
00:29:10,560 --> 00:29:14,440
Speaker 1: mentioned earlier, is in treasuries and agency nbs to the

509
00:29:14,480 --> 00:29:17,360
Speaker 1: tune of well put five trillion dollars the past couple

510
00:29:17,360 --> 00:29:20,360
Speaker 1: of years. So we have this dynamic. We have a

511
00:29:20,400 --> 00:29:24,080
Speaker 1: similar dynamic playing out, but just not in the report market.

512
00:29:24,080 --> 00:29:28,240
Speaker 1: The semiround tremendous demand, continued demand for financing by the

513
00:29:28,320 --> 00:29:32,320
Speaker 1: U S trusury met by the marginal lender in the market,

514
00:29:32,360 --> 00:29:35,880
Speaker 1: the commercial banks having less cash to lend. So if

515
00:29:35,920 --> 00:29:38,560
Speaker 1: there is another blow up because of the q T,

516
00:29:39,040 --> 00:29:42,680
Speaker 1: it's very likely to be in my view, in the

517
00:29:42,680 --> 00:29:46,600
Speaker 1: treasury market, since the same dynamic is playing out, And

518
00:29:46,680 --> 00:29:50,800
Speaker 1: what that could eventually mean is some kind of let's say,

519
00:29:50,840 --> 00:29:54,719
Speaker 1: liquidity backstop for the treasury market rather than for the report,

520
00:29:54,760 --> 00:29:58,000
Speaker 1: which I think is probably very logical given what the

521
00:29:58,000 --> 00:30:00,960
Speaker 1: FED is already doing. Uh if you room call. As

522
00:30:00,960 --> 00:30:05,520
Speaker 1: he noted Tracy, when the report market blew up, FED

523
00:30:05,600 --> 00:30:09,000
Speaker 1: stepped in with an emergency liquidity facility for report. When

524
00:30:09,040 --> 00:30:11,400
Speaker 1: the ethics spot lines blow up, the FED has their

525
00:30:11,400 --> 00:30:14,240
Speaker 1: FICX swot lines. When the commercial paper market blows up,

526
00:30:14,280 --> 00:30:16,360
Speaker 1: they have their you know they have their tools for that.

527
00:30:16,440 --> 00:30:18,800
Speaker 1: In the past, when the treasury market blew up, it's

528
00:30:19,320 --> 00:30:21,680
Speaker 1: they just did qui, which is a very blunt instrument.

529
00:30:22,200 --> 00:30:24,959
Speaker 1: A more calibrated instrument would probably be some kind of

530
00:30:25,040 --> 00:30:28,840
Speaker 1: emergency backstop willing to buy treasuries that you know, a

531
00:30:28,880 --> 00:30:31,920
Speaker 1: set interest rate set above the market as a liquidity backstop.

532
00:30:32,000 --> 00:30:36,000
Speaker 1: There is a standing report facility right exactly that provides

533
00:30:36,160 --> 00:30:40,040
Speaker 1: emergency liquidity. If you have treasuries, you can repull that

534
00:30:40,120 --> 00:30:43,480
Speaker 1: for cash. So it provides emergency cash. It doesn't have

535
00:30:44,400 --> 00:30:47,320
Speaker 1: doesn't put a ceiling on rates in case the trajey

536
00:30:47,320 --> 00:30:51,400
Speaker 1: market blows up because it's selling in theory, why is

537
00:30:51,440 --> 00:30:56,000
Speaker 1: that not sufficient to avoid a blow up? If any holder,

538
00:30:56,080 --> 00:30:59,200
Speaker 1: if a holder of treasuries can know that there is

539
00:30:59,280 --> 00:31:01,840
Speaker 1: this there's window or the desk out there that will

540
00:31:01,880 --> 00:31:05,520
Speaker 1: swap at any time treasuries for cash, why doesn't they

541
00:31:05,520 --> 00:31:07,920
Speaker 1: add short circuit the sort of run dynamics in the

542
00:31:07,920 --> 00:31:11,760
Speaker 1: first place. Exactly, So that has to do with a

543
00:31:11,800 --> 00:31:14,440
Speaker 1: balance sheet constraints, and I'll explain that a little bit

544
00:31:14,480 --> 00:31:18,080
Speaker 1: more so. When the people who have access to the

545
00:31:18,080 --> 00:31:22,920
Speaker 1: FEDS report facility are the primary dealers, So if you

546
00:31:23,000 --> 00:31:25,880
Speaker 1: want to have liquidity flow from the standard report facility

547
00:31:25,960 --> 00:31:28,560
Speaker 1: to the market, it has to go through the primary dealers.

548
00:31:28,600 --> 00:31:31,520
Speaker 1: And how that would play out is the primary dealer

549
00:31:31,560 --> 00:31:34,280
Speaker 1: would borrow from the FED, let's say a hundred dollars

550
00:31:34,280 --> 00:31:37,400
Speaker 1: from the FED, and then let's say, on the asset side,

551
00:31:38,040 --> 00:31:40,520
Speaker 1: lend out that hundred dollars, so it expands the balance

552
00:31:40,560 --> 00:31:44,800
Speaker 1: sheet of a primary dealer. Primary dealers are basically like

553
00:31:44,840 --> 00:31:48,000
Speaker 1: the pipes to which money flows from UH the FED

554
00:31:48,280 --> 00:31:52,600
Speaker 1: or money market fled cash investors into the broader market PREGFC.

555
00:31:52,840 --> 00:31:54,760
Speaker 1: There is not a lot of limit to how why

556
00:31:54,840 --> 00:31:57,400
Speaker 1: these pipes could be post GFC, because I'm all the

557
00:31:57,480 --> 00:32:00,800
Speaker 1: number of regulations the pipes actually have kind of a

558
00:32:00,840 --> 00:32:04,640
Speaker 1: fixed size. So for example, if there's a tremendous need

559
00:32:04,720 --> 00:32:08,040
Speaker 1: for liquidity, a primary Julie cannot borrow like a hundred

560
00:32:08,040 --> 00:32:09,880
Speaker 1: billion dollars from the FED and just lend it out

561
00:32:09,880 --> 00:32:13,120
Speaker 1: to the market because they would hit these regulatory constraints.

562
00:32:13,160 --> 00:32:16,440
Speaker 1: From a high level, pre GFC, the dealers were doing

563
00:32:16,480 --> 00:32:19,480
Speaker 1: about three trillion dollars in repo. Now that's you know

564
00:32:19,480 --> 00:32:22,320
Speaker 1: pre GFC lets in two thousand and seven. Today they're

565
00:32:22,360 --> 00:32:25,280
Speaker 1: doing about one point five trillion so you know, everything

566
00:32:25,480 --> 00:32:28,240
Speaker 1: in the market has gone much bigger, but yet the repo,

567
00:32:28,400 --> 00:32:31,680
Speaker 1: the amount of repo primary dealers do has gone smaller

568
00:32:31,720 --> 00:32:34,640
Speaker 1: by half. And that's those are the pipes of the

569
00:32:34,680 --> 00:32:38,560
Speaker 1: financial system becoming more constrained. And also why we had

570
00:32:38,560 --> 00:32:41,800
Speaker 1: these blow ups in March. Dealers, even though at the

571
00:32:41,840 --> 00:32:44,920
Speaker 1: time they also had access to this repo facility that

572
00:32:45,000 --> 00:32:47,760
Speaker 1: FED had their balance sheets, the pipes were simply not

573
00:32:47,840 --> 00:32:51,000
Speaker 1: wide enough to to accommodate all that. So um, they

574
00:32:51,000 --> 00:32:53,360
Speaker 1: could there are regulatory things they can do to tweak that,

575
00:32:53,600 --> 00:32:57,240
Speaker 1: and I think there's work being done on that side. Um,

576
00:32:57,280 --> 00:33:16,400
Speaker 1: but at the moment it's not complete yet. So what

577
00:33:16,400 --> 00:33:20,080
Speaker 1: would cause the FED to pause QT? Like, what would

578
00:33:20,080 --> 00:33:22,560
Speaker 1: be the catalyst for it to step back and go,

579
00:33:23,440 --> 00:33:26,160
Speaker 1: wait a second, we're doing this set too rapid a pace,

580
00:33:26,480 --> 00:33:29,840
Speaker 1: or we're doing too much too soon and basically reconsider.

581
00:33:30,720 --> 00:33:33,600
Speaker 1: So I think thinking is that eventually the FED would

582
00:33:33,600 --> 00:33:36,800
Speaker 1: become well hike or do qut and eventually something will

583
00:33:36,840 --> 00:33:39,959
Speaker 1: blow up and they'll have to to reverse. I actually

584
00:33:40,040 --> 00:33:44,040
Speaker 1: think that's that's totally accurate in what happened in the past.

585
00:33:44,200 --> 00:33:47,080
Speaker 1: But I think what's happening now is that the FED

586
00:33:47,160 --> 00:33:51,120
Speaker 1: actually has enough tools so that they don't have to stop.

587
00:33:51,320 --> 00:33:54,440
Speaker 1: So if you think about broadly speaking, the FETE has

588
00:33:54,480 --> 00:33:57,760
Speaker 1: basically become a one mandate bank. For the moment, the

589
00:33:57,840 --> 00:34:00,040
Speaker 1: power was telling you that it's it's can can a

590
00:34:00,120 --> 00:34:03,200
Speaker 1: bit to price stability is unconditional. He's telling you that

591
00:34:03,680 --> 00:34:06,600
Speaker 1: full employment is conditional price ability. So the only thing

592
00:34:06,680 --> 00:34:10,200
Speaker 1: that happens that matters for him right now is is inflation.

593
00:34:10,280 --> 00:34:13,120
Speaker 1: And so he's going to be very aggressive in his

594
00:34:13,400 --> 00:34:17,839
Speaker 1: monetary tightening, and that means of course not stopping QUT

595
00:34:18,000 --> 00:34:21,279
Speaker 1: and not stopping grade hikes. He can do that now

596
00:34:21,480 --> 00:34:24,520
Speaker 1: because the FED has rolled out so many new facilities

597
00:34:24,840 --> 00:34:28,520
Speaker 1: such that wide sectors of the economy can be supported

598
00:34:28,960 --> 00:34:34,920
Speaker 1: even if something breaks. The FED during March pioneered facilities

599
00:34:35,000 --> 00:34:38,000
Speaker 1: to make the blender of last resort for wide range

600
00:34:38,040 --> 00:34:41,600
Speaker 1: of markets and for ride range of sectors. For example,

601
00:34:42,200 --> 00:34:45,520
Speaker 1: their back stopping the municipal bond market through their Municipal

602
00:34:45,560 --> 00:34:48,480
Speaker 1: Licuity facility lasts him around, and the corporate bond market

603
00:34:48,560 --> 00:34:52,040
Speaker 1: through the Corporate credit facility and Becauceivably they could also

604
00:34:52,120 --> 00:34:56,320
Speaker 1: have new treasury facilities as well. So I think eventually

605
00:34:56,440 --> 00:34:58,840
Speaker 1: something will break, because it always breaks but it doesn't

606
00:34:58,880 --> 00:35:01,160
Speaker 1: mean that they'll stop, just means that they could use

607
00:35:01,239 --> 00:35:06,080
Speaker 1: their facilities to further extend their tidying. These facilities, in

608
00:35:06,200 --> 00:35:10,239
Speaker 1: my view, greatly extend the possibility of of how restrictive

609
00:35:10,280 --> 00:35:14,879
Speaker 1: Monterrey policy can be simply because the remove liquidity risk. Wait, sorry,

610
00:35:14,920 --> 00:35:16,560
Speaker 1: can you just explain that a little further. You're saying

611
00:35:16,600 --> 00:35:22,839
Speaker 1: these new facilities, the facilities that were pioneered in these

612
00:35:22,880 --> 00:35:27,000
Speaker 1: new facilities that were pioneered in Mary, the explicit backstopping

613
00:35:27,080 --> 00:35:30,080
Speaker 1: of the credit markets, the MUNI facility, which was obviously

614
00:35:30,239 --> 00:35:33,920
Speaker 1: extraordinary and sort of you know, this brand new thing explained,

615
00:35:33,960 --> 00:35:35,840
Speaker 1: How do you see them potentially being used? Because I

616
00:35:35,840 --> 00:35:38,640
Speaker 1: feel like these facilities have largely been forgotten about. No

617
00:35:38,680 --> 00:35:40,560
Speaker 1: one ever talks about either one of those these days,

618
00:35:40,800 --> 00:35:44,080
Speaker 1: exactly exactly, so they've all forgotten and they're not commissioned

619
00:35:44,160 --> 00:35:46,719
Speaker 1: right now. So what I'm saying is that if q

620
00:35:46,960 --> 00:35:50,560
Speaker 1: T or if FED rc TIKES actually breaks something in

621
00:35:50,560 --> 00:35:53,239
Speaker 1: the market, the FED does not have to stop. It

622
00:35:53,360 --> 00:35:55,880
Speaker 1: does not have to stop because it can continue to

623
00:35:56,040 --> 00:35:59,040
Speaker 1: keep the financial markets coming along so it can repair,

624
00:35:59,520 --> 00:36:01,920
Speaker 1: it can can continue to tighten in pursuit of its

625
00:36:01,960 --> 00:36:06,800
Speaker 1: inflation goal. While sort of more strategically repairing potential breaks

626
00:36:06,840 --> 00:36:11,560
Speaker 1: in the financial market exactly, Joe, Okay. Interesting because again,

627
00:36:12,280 --> 00:36:14,680
Speaker 1: the FED has become lender of last resort to such

628
00:36:14,719 --> 00:36:18,319
Speaker 1: a wide wide range of market participants, from the corporations,

629
00:36:18,800 --> 00:36:22,480
Speaker 1: from the to the municipals, and indirectly to small businesses

630
00:36:22,960 --> 00:36:26,239
Speaker 1: through the banking system through their mainstream lending facility. So

631
00:36:27,000 --> 00:36:31,759
Speaker 1: it's basically such so significantly expanded their footprint that there's

632
00:36:31,880 --> 00:36:35,800
Speaker 1: less reliance on the transmission of monetary policy through the market,

633
00:36:36,320 --> 00:36:39,120
Speaker 1: and you can kind of, uh, well, it's not ideal,

634
00:36:39,200 --> 00:36:41,279
Speaker 1: but you can kind of indirectly reach it through these

635
00:36:41,320 --> 00:36:44,440
Speaker 1: programs such that even if something breaks, it doesn't actually

636
00:36:44,520 --> 00:36:48,919
Speaker 1: mean they have to back down, lower rates and continue QB,

637
00:36:49,239 --> 00:36:51,960
Speaker 1: especially if inflation is too high. What's your bet on

638
00:36:52,160 --> 00:36:55,239
Speaker 1: what could break if you had to, if you had

639
00:36:55,280 --> 00:36:57,719
Speaker 1: to wager something right now, like, what would it be?

640
00:36:57,840 --> 00:37:01,080
Speaker 1: Where's the biggest area of weakness. I still believe the

641
00:37:01,120 --> 00:37:05,799
Speaker 1: trophy market is the highest risk. That's first, because as

642
00:37:05,880 --> 00:37:08,680
Speaker 1: I mentioned the report, breakup dynamics that we saw in

643
00:37:08,719 --> 00:37:11,440
Speaker 1: the prior QUTY are playing out in the trophy market.

644
00:37:12,280 --> 00:37:15,880
Speaker 1: Have tremendous supply coming up the few years, the demand,

645
00:37:16,840 --> 00:37:19,360
Speaker 1: it doesn't seem like it's there because the marginal investor

646
00:37:19,480 --> 00:37:23,279
Speaker 1: is disappearing and we have very weak, low liquidity, weak

647
00:37:23,400 --> 00:37:26,400
Speaker 1: market structure, and just watching the trophy market over the

648
00:37:26,440 --> 00:37:30,120
Speaker 1: past few weeks seems like it's becoming more volatile. So

649
00:37:30,280 --> 00:37:33,280
Speaker 1: I think that's probably the place that that is most

650
00:37:33,440 --> 00:37:36,279
Speaker 1: likely to break this time around. So one of the

651
00:37:37,600 --> 00:37:39,400
Speaker 1: things you know, as you were talking about in the beginning,

652
00:37:39,480 --> 00:37:41,839
Speaker 1: it can be sort of hard to well, it can

653
00:37:41,880 --> 00:37:44,520
Speaker 1: be hard to predict what's going to break. It can

654
00:37:44,600 --> 00:37:48,640
Speaker 1: also be hard to predict where the liquidity is going

655
00:37:48,800 --> 00:37:50,960
Speaker 1: to get drained out of the system first. Like all

656
00:37:51,040 --> 00:37:53,760
Speaker 1: of these things, it doesn't seem like it's a hard science,

657
00:37:53,920 --> 00:37:58,840
Speaker 1: and anticipating it is. This sort of fundamentally why the

658
00:37:59,000 --> 00:38:05,120
Speaker 1: FED is so uncomfortable quantifying the tightening effect of balance

659
00:38:05,160 --> 00:38:09,000
Speaker 1: sheet policy, because you know, it's sort of easy to see,

660
00:38:09,120 --> 00:38:11,960
Speaker 1: like the transmission mechanism of a rate increase. It's like

661
00:38:12,360 --> 00:38:14,160
Speaker 1: your high rates and rates go up, and then you

662
00:38:14,239 --> 00:38:16,640
Speaker 1: see it in mortgages and car loans and that titan

663
00:38:16,719 --> 00:38:20,320
Speaker 1: is the housing market. It's somewhat straightforward, I think, whereas

664
00:38:20,320 --> 00:38:23,040
Speaker 1: if there's so much uncertainty about where is the liquidity

665
00:38:23,200 --> 00:38:26,960
Speaker 1: going to come from or be pulled from? It seems

666
00:38:27,040 --> 00:38:30,600
Speaker 1: that makes it inherently a much tougher tool to quantify

667
00:38:30,680 --> 00:38:34,399
Speaker 1: and calibrate. I agree completely with that, and I don't

668
00:38:34,480 --> 00:38:38,040
Speaker 1: actually know if the FED under understands this. If you hear,

669
00:38:38,320 --> 00:38:40,480
Speaker 1: I think there's work from the ft that's also been

670
00:38:40,560 --> 00:38:43,160
Speaker 1: mentioned from by Governor Waller that you know, let's say

671
00:38:43,160 --> 00:38:46,560
Speaker 1: two trillon dollars of QUEI is a QT is equal

672
00:38:46,600 --> 00:38:50,040
Speaker 1: to like fifty basis points. I suspect that's probably not true,

673
00:38:50,120 --> 00:38:53,000
Speaker 1: and it will be something that they wish they didn't say,

674
00:38:53,200 --> 00:38:55,880
Speaker 1: because the thing is, there's so many moving parts to this.

675
00:38:56,080 --> 00:38:57,880
Speaker 1: There's so many ways that it can go. It's not

676
00:38:58,000 --> 00:39:00,680
Speaker 1: something that can fit it in an equation. Now, if

677
00:39:00,719 --> 00:39:02,480
Speaker 1: you want to approach the world as if you are

678
00:39:02,560 --> 00:39:05,359
Speaker 1: a giant equation, you need to have relationships that are

679
00:39:05,400 --> 00:39:07,919
Speaker 1: consistent and don't change. And this is very much true

680
00:39:07,920 --> 00:39:11,360
Speaker 1: in physics. If I drop rock here, uh, you know,

681
00:39:11,560 --> 00:39:14,200
Speaker 1: my points per second square goes down, saying if I

682
00:39:14,320 --> 00:39:15,719
Speaker 1: dropped it in London, or if I dropped it a

683
00:39:15,840 --> 00:39:18,520
Speaker 1: hundred years ago. That works well for things that don't change.

684
00:39:18,600 --> 00:39:21,480
Speaker 1: But if you're looking at the financial markets, The relationships

685
00:39:21,520 --> 00:39:24,520
Speaker 1: are always changing their different regimes, and there are different

686
00:39:24,560 --> 00:39:28,560
Speaker 1: actors and different regulatory changes, so you just really can't

687
00:39:28,680 --> 00:39:31,680
Speaker 1: know what will happen. In the estimate, I think is

688
00:39:31,880 --> 00:39:35,120
Speaker 1: is just not very useful, and so with in that sense,

689
00:39:35,160 --> 00:39:37,680
Speaker 1: it's kind of good that they get out of this. Yeah,

690
00:39:38,600 --> 00:39:41,520
Speaker 1: this is a related question, But what's the future of

691
00:39:41,640 --> 00:39:45,200
Speaker 1: the FED and its relationship with financial markets in the

692
00:39:45,320 --> 00:39:48,239
Speaker 1: sense that you know, as you've been describing now for

693
00:39:48,360 --> 00:39:51,840
Speaker 1: the past at least the past ten years, you know,

694
00:39:51,960 --> 00:39:54,720
Speaker 1: more than a decade since two thousand eight, Whenever something

695
00:39:54,800 --> 00:39:57,440
Speaker 1: goes wrong, the FED comes up with some sort of

696
00:39:57,600 --> 00:40:01,320
Speaker 1: new program to enable it to keep pursuing its policy

697
00:40:01,360 --> 00:40:04,200
Speaker 1: goals or keep doing what it was doing. Is that

698
00:40:04,680 --> 00:40:07,760
Speaker 1: just how it's going to be for the foreseeable future?

699
00:40:07,920 --> 00:40:10,440
Speaker 1: You know, something goes wrong, the FED comes up with

700
00:40:10,520 --> 00:40:13,160
Speaker 1: a new program, it gets added, Eventually it becomes the

701
00:40:13,200 --> 00:40:16,080
Speaker 1: new normal. Eventually something else goes wrong and there's a

702
00:40:16,120 --> 00:40:18,640
Speaker 1: new program, and so on and so forth. Or is

703
00:40:18,719 --> 00:40:22,440
Speaker 1: there going to be a larger shift or break in

704
00:40:22,560 --> 00:40:26,279
Speaker 1: this pattern at some point? I think going forward, I

705
00:40:26,360 --> 00:40:30,200
Speaker 1: think the inventible outcome is probably a reversal of the

706
00:40:30,360 --> 00:40:35,239
Speaker 1: Fedatricia Court. Simply because the FED itself is becoming so

707
00:40:35,320 --> 00:40:37,640
Speaker 1: much more involved in the markets, it's going to need

708
00:40:38,000 --> 00:40:40,920
Speaker 1: to have more accountability. It's it's going it's it's essentially

709
00:40:41,000 --> 00:40:43,680
Speaker 1: becoming lend of lasted work to everyone in the system.

710
00:40:43,760 --> 00:40:46,560
Speaker 1: But also because of changes in the structure of the

711
00:40:46,760 --> 00:40:49,520
Speaker 1: economy such that the FED probably can't carry out its

712
00:40:49,560 --> 00:40:51,960
Speaker 1: task the same way that it was able to say

713
00:40:52,040 --> 00:40:54,640
Speaker 1: at its inception. And this has to do with how

714
00:40:54,840 --> 00:40:57,840
Speaker 1: the public sector is just the bigger part of the economy.

715
00:40:58,000 --> 00:41:01,320
Speaker 1: For example, if you think back hundred years ago, the

716
00:41:01,840 --> 00:41:04,239
Speaker 1: government was a very small part of the economy, and

717
00:41:04,560 --> 00:41:08,279
Speaker 1: the FED, with its mandate of controlling inflation, it can

718
00:41:08,360 --> 00:41:11,560
Speaker 1: simply adjust interest rates, and private actors respond to that.

719
00:41:11,760 --> 00:41:14,400
Speaker 1: It works much better. If you are a private sector actor,

720
00:41:14,960 --> 00:41:17,560
Speaker 1: you care about the price of money, and if industrates

721
00:41:17,600 --> 00:41:20,720
Speaker 1: are higher, you moderate your economic activity and af ingistration

722
00:41:20,840 --> 00:41:25,840
Speaker 1: or lower. You know, maybe you spend more um. But

723
00:41:26,520 --> 00:41:29,160
Speaker 1: the structure of the economy has changed so much over

724
00:41:29,239 --> 00:41:31,960
Speaker 1: the past hundred years such that there's a greater part

725
00:41:32,040 --> 00:41:34,840
Speaker 1: of the economy that's basically the public sector, and the

726
00:41:34,920 --> 00:41:38,080
Speaker 1: public sector doesn't really care about interest rates. So when

727
00:41:38,120 --> 00:41:40,600
Speaker 1: the FED hikes. When the FED cuts, that doesn't really

728
00:41:40,640 --> 00:41:44,000
Speaker 1: affect their economic activity. Their economic activity has to be

729
00:41:44,080 --> 00:41:48,920
Speaker 1: effected through the legislative process. So as this trend continues,

730
00:41:49,360 --> 00:41:52,640
Speaker 1: as one, a greater part of the economy becomes insensitive

731
00:41:52,880 --> 00:41:56,439
Speaker 1: to the FEDS interest rates, thus making the FED less

732
00:41:56,440 --> 00:42:00,480
Speaker 1: effective in controlling rates. And two, as a FED becomes

733
00:42:01,040 --> 00:42:03,600
Speaker 1: much more involved as lender of last resort to a

734
00:42:03,680 --> 00:42:07,080
Speaker 1: wide range of the market, essentially becoming more in the

735
00:42:07,160 --> 00:42:10,439
Speaker 1: allocation of credit business, which I think is probably something

736
00:42:10,480 --> 00:42:14,160
Speaker 1: that more probably belongs to, if not the private sector,

737
00:42:14,239 --> 00:42:17,880
Speaker 1: at least someone that has public mandate. So it seems

738
00:42:18,040 --> 00:42:20,359
Speaker 1: we're heading towards the world. It will make more sense

739
00:42:20,600 --> 00:42:23,640
Speaker 1: or more coordination between Fed and Treasury to achieve these

740
00:42:23,719 --> 00:42:26,560
Speaker 1: goals simply because the FED is doing more stuff that

741
00:42:26,760 --> 00:42:31,760
Speaker 1: is physical policy alike, and also it has less ability

742
00:42:31,840 --> 00:42:35,440
Speaker 1: to influence economic outcomes. All right, Joseph, it was so

743
00:42:35,600 --> 00:42:37,920
Speaker 1: good having you back on odd Lots. Thank you so much,

744
00:42:38,120 --> 00:42:40,800
Speaker 1: really appreciate it. Thank you so much for inviting me.

745
00:42:40,840 --> 00:42:43,840
Speaker 1: I love odd Lots and I really appreciate the opportunity.

746
00:42:43,960 --> 00:42:46,839
Speaker 1: Thanks Tracy, and thanks Joe, thank you. It's great, great chat.

747
00:43:00,640 --> 00:43:03,600
Speaker 1: So Joe, I thought that was incredibly interesting and really

748
00:43:03,680 --> 00:43:05,719
Speaker 1: good to get into the weeds of some of this.

749
00:43:06,040 --> 00:43:09,239
Speaker 1: And also, I mean, one thing that is becoming clear

750
00:43:09,360 --> 00:43:12,160
Speaker 1: from recent episodes is that lots of people seem to

751
00:43:12,239 --> 00:43:15,640
Speaker 1: be saying that liquidity in the treasury market has deteriorated

752
00:43:15,719 --> 00:43:19,200
Speaker 1: for various reasons and that there are some vulnerabilities there.

753
00:43:19,560 --> 00:43:22,760
Speaker 1: But Joseph's mentioned of the idea of treasury is becoming

754
00:43:22,880 --> 00:43:27,080
Speaker 1: less like cash um or less cash like in the

755
00:43:27,160 --> 00:43:29,279
Speaker 1: way they are traded and in their position in the

756
00:43:29,360 --> 00:43:33,080
Speaker 1: financial system. That would actually be a sea change for markets.

757
00:43:33,200 --> 00:43:36,680
Speaker 1: I think it's weird because, I mean, clearly, with the

758
00:43:36,800 --> 00:43:42,239
Speaker 1: existence of the standing repo facility, the FEDS goal is

759
00:43:42,320 --> 00:43:45,520
Speaker 1: to make it more explicitly cash like. I mean, that's

760
00:43:45,560 --> 00:43:48,640
Speaker 1: the idea right there. Similar it's always been somewhat money

761
00:43:48,719 --> 00:43:52,839
Speaker 1: like and similar to cash and okay, and now they

762
00:43:52,880 --> 00:43:56,239
Speaker 1: have this formal standing repo facility so that at least

763
00:43:56,280 --> 00:43:59,399
Speaker 1: the primary dealers can swap them into cash at any time,

764
00:43:59,480 --> 00:44:02,080
Speaker 1: even when it is not an emergency. So the fact

765
00:44:02,160 --> 00:44:06,320
Speaker 1: that like liquidity is still deteriorating, the fact that you know,

766
00:44:06,400 --> 00:44:09,080
Speaker 1: we have had all these issues, uh, you know, raises

767
00:44:09,200 --> 00:44:12,160
Speaker 1: it to his point. There's clearly still a lot of

768
00:44:12,719 --> 00:44:15,760
Speaker 1: unfinished business. Yeah. The other thing that kind of struck

769
00:44:15,840 --> 00:44:19,000
Speaker 1: me from that conversation was his description of how when

770
00:44:19,040 --> 00:44:21,840
Speaker 1: the r r P. I don't think we ever actually

771
00:44:21,880 --> 00:44:23,839
Speaker 1: said what the r r P stands for, but it's

772
00:44:23,880 --> 00:44:27,920
Speaker 1: the reverse repurchase facility. But when the r RP goes up,

773
00:44:28,280 --> 00:44:31,360
Speaker 1: it doesn't necessarily mean that liquidity in the overall system

774
00:44:31,440 --> 00:44:33,640
Speaker 1: is going up, which I think there are still a

775
00:44:33,719 --> 00:44:35,400
Speaker 1: lot of people out there that look at the r

776
00:44:35,480 --> 00:44:38,880
Speaker 1: r P at two trillion dollars or whatever and they

777
00:44:38,960 --> 00:44:42,240
Speaker 1: go like, oh, liquidity slashing around the system by everything

778
00:44:42,960 --> 00:44:46,239
Speaker 1: I'm thinking. I'm thinking in particular of a certain sub

779
00:44:46,320 --> 00:44:48,839
Speaker 1: credit where the r r P is a really big

780
00:44:48,880 --> 00:44:52,640
Speaker 1: talking point. But Joseph's point that actually the RRP going

781
00:44:52,719 --> 00:44:55,120
Speaker 1: up means liquidity might not be going out of the

782
00:44:55,160 --> 00:44:57,920
Speaker 1: banking system and so you know, financial conditions are tightening,

783
00:44:58,040 --> 00:45:01,320
Speaker 1: that's worth remembering. And just to his is broader point

784
00:45:01,640 --> 00:45:05,040
Speaker 1: which he hit a few different ways, like the sort

785
00:45:05,080 --> 00:45:10,799
Speaker 1: of relationship between quantitative tightening and where liquidity can come

786
00:45:10,840 --> 00:45:12,680
Speaker 1: out of the market at any given time and to

787
00:45:13,040 --> 00:45:16,319
Speaker 1: some degree, you know, the unpredictability of it, the faith

788
00:45:16,600 --> 00:45:19,600
Speaker 1: it's different under different regimes. I think that may be

789
00:45:19,760 --> 00:45:23,480
Speaker 1: like the clearest explanation of like why the FED and

790
00:45:23,560 --> 00:45:26,840
Speaker 1: nobody else really even like talks about the tightening effects

791
00:45:26,880 --> 00:45:29,080
Speaker 1: of QT, in part because like it's just not nearly

792
00:45:29,200 --> 00:45:32,160
Speaker 1: as straightforward or predictable. So the idea of like putting

793
00:45:32,200 --> 00:45:35,200
Speaker 1: a number on it or saying like, okay, QT is

794
00:45:35,280 --> 00:45:38,399
Speaker 1: like worth this many rate cuts or sorry raid hikes

795
00:45:38,440 --> 00:45:43,320
Speaker 1: or whatever, like it seems way harder to judge. Yeah, no,

796
00:45:43,880 --> 00:45:45,919
Speaker 1: I actually just keep the balance sheet big and forget

797
00:45:45,920 --> 00:45:48,960
Speaker 1: about it. Seems like it cousable. That's that's if I

798
00:45:49,000 --> 00:45:50,920
Speaker 1: were there, like, let's just yeah, it's just too much

799
00:45:50,960 --> 00:45:54,600
Speaker 1: of a headache. Figure it's future and whatever. I just

800
00:45:54,680 --> 00:45:56,160
Speaker 1: keep it there. That would be that was well, I

801
00:45:56,200 --> 00:45:58,160
Speaker 1: mean we were on the phone. That would be my vote.

802
00:45:58,239 --> 00:46:01,359
Speaker 1: You know what everyone can pain for Joe for FED

803
00:46:01,480 --> 00:46:06,320
Speaker 1: share Uh, you know, a simplified FED, simplified open market operations.

804
00:46:07,200 --> 00:46:10,759
Speaker 1: That's Joe's that's Joe's campaign platform. Balancie. It only goes

805
00:46:10,800 --> 00:46:12,960
Speaker 1: in one direction when I'm on the bed, only get

806
00:46:13,400 --> 00:46:15,040
Speaker 1: We never do the opposite, you know what. I think

807
00:46:15,080 --> 00:46:17,759
Speaker 1: that might actually be a very successful talking point. Okay,

808
00:46:17,920 --> 00:46:20,839
Speaker 1: let's leave it there before we say anything else sounds good.

809
00:46:20,880 --> 00:46:23,920
Speaker 1: Let's leave it there. Okay, this has been another episode

810
00:46:24,000 --> 00:46:26,480
Speaker 1: of the All Thoughts podcast. I'm Tracy Alloway. You can

811
00:46:26,520 --> 00:46:29,279
Speaker 1: follow me on Twitter at Tracy Alloway and I'm Joe

812
00:46:29,360 --> 00:46:31,839
Speaker 1: Why Isn't Though. You can follow me on Twitter at

813
00:46:31,880 --> 00:46:35,080
Speaker 1: the Stalwart. Follow our guest Joseph Wange on Twitter. He's

814
00:46:35,200 --> 00:46:39,799
Speaker 1: at fed Guy twelve. Follow our producer Kermen Rodriguez at

815
00:46:39,920 --> 00:46:43,360
Speaker 1: Kermen armand, and check out all of the Bloomberg podcasts

816
00:46:43,440 --> 00:46:47,320
Speaker 1: on Twitter under the handle at podcasts. Thanks for listening

817
00:47:08,520 --> 00:47:10,400
Speaker 1: year to