We’ve all been taught to associate low money rates with stimulus, and especially high money rates with hardship. And that may be true in certain circumstances. This theoretical world of easy interpretation does not exist outside the media or the econometric models of central banks.
History, even recent, invites at the very least a more nuanced approach.
Take, for example, the situation in December 2007 when the Federal Reserve, under its still relatively new chairman, Ben Bernanke, began to realize that subprime mortgages were not contained (because they were not of subprime). After the clear breakdown of August 9, the Federal Open Market Committee (FOMC) had simply followed its instruction manual: August (primary credit), then September (federal funds target) rate cuts, and a clear “message” for more “help”. ” in the form of even moving forward.
Over the following weeks, the chaos in the monetary world only worsened. Bernanke’s group of policymakers were forced to take actions we never imagined by a Federal Reserve regime.
The unveiling of the term auction facility (TAF) auctions announced on December 12, 2007, along with the implementation of foreign dollar swaps, was met with widespread shock and disbelief. We were always told that the most powerful monetary institution, the money printer in the world, could solve any problem with a simple stroke of a simple rate cut.
Instead, the TAF auction was initially (and continuously) overwhelmed by “American banks” with mostly German names (US-based subsidiaries of mostly German foreign parent companies). Add to this overseas flavor the obvious offshore nature of foreign dollar swaps, and if you had been paying attention you would have very quickly realized what a global dollar (eurodollar) panic this was unlike to what is taught in antiquated and outdated textbook theories.
The first of these TAF operations took place on 17 December. The next day, December 18, the effective federal funds rate (EFF; the market weighted–median of all unsecured interbank lending taking place in the fed funds market) plunged from 4.31% to 4.16%. At that time, the FOMC’s target was 4.25%, meaning the EFF was significantly lower than officials demanded.
The following day, December 19, the EFF would lose another 18 basis points (bps), falling below 4%.
Wasn’t it just the TAF auctions that poured significant amounts ($20 billion) of cash and liquidity into these markets?
No. Leaving aside legitimate objections about what’s on the other end (bank reserves) and whether these are useful forms of money (they aren’t), the Federal Reserve has been sterilization his activities anyway. In other words, most of Bernanke’s embattled policymakers tried to redistribute funding to weaker companies (those that would bid the most for reserves).
This does not and cannot explain both the presence and persistence of low EFF before and after these auctions, indeed, from the very beginning throughout the entire monetary policy (not financial) panic.
And it wasn’t just a problem for federal funds. Repo rates such as that of the GC repo (or general guarantee, i.e. a secured or guaranteed short-term interbank funding arrangement using essentially generic US Treasury securities as collateral) would often fall much more than the ‘EFF.
On December 18, 2007, the GC repo rate was only 3.525%, a whopping 63.5 basis points lower than EFF and 72.5 basis points below the purpose of the Federal Reserve’s federal funds. Then the rate fell again on December 19. These are chaotic results, clear signs of massive disorder, despite the TAF and the Fed’s (unnecessary) foreign swaps, even if illustrated by fall monetary rates.
Transaction-based rates like EFF and GC repo do not take this into account. doesn’t occur in these markets. How could they? If, for example, a subprime borrower in fed funds (remember, unsecured) who yesterday was charged a higher rate by the market to lend because of their perceived risk profile is completely shut out of the market today, the calculated median effective rate (the effective rate) for the entire market will decline because of simple statistics.
And if the market were to decide to withhold fed funds from lending to a large number of high-risk counterparties out of general fear, their typically higher-rate trades disappear from the calculations, skewing the mean and median downward. The more illiquid the market becomes for a wider variety of borrowers, aside from just the best of the best (those paying low rates), the more lower the transaction-based rate will drop.
In this situation, the decline in money market rates represents quite the opposite of a stimulus.
The same goes for repos: if there are not enough interbank borrowers with acceptable collateral, cash lenders will resort to much lower rates from borrowers who can post good collateral. , which most commonly means US Treasuries, also explaining the same found behavior of the GC deposit.
No matter what the Federal Reserve tried, nothing stemmed the disaster. From the beginning of August 9, 2007, until the actual end of the currency panic in March 2009, you can clearly observe (in the chart above) that there was nothing but chaos and an absolutely obvious mess, more often than not (the London Interbank Offered Rate [LIBOR] was the notable exception, for reasons I won’t go into today) presented in the form of low money rates (including treasury bills, for direct collateral purposes).
As of August 24, 2022, the GC repo rate (or broad general collateral, as it is now called) stood at 2.26%. Another high-interest figure, the Secured Overnight Funding Rate (SOFR), which encompasses a larger volume of repo funding, was pegged at 2.27%. Yields on four-week Treasuries were thought to stand at 2.29%, after being much, much lower in recent days.
All of these rates are below the Federal Reserve’s so-called “floor,” the reverse repo rate (the way the Fed claims to manage money markets has changed since 2008, no longer choosing a single target as it does). had done for decades until its great failures during the crisis), which currently stands at 2.30%. Even EFF on Aug. 24 was just 2 basis points above.
Over the past few months, SOFR, repo and Treasuries have been much further below the Fed “floor” than they are today. And when they were this low, that’s also when we experienced glaring illiquidity and chaos in global markets, as happened in mid-March and especially mid-June .
These falling money rates were not “stimulus” and had little to do with the Federal Reserve. Similar to the 2007 and 2008 terms, they describe a very different situation from the logic that “inflation is due to excessive printing of money” that is widely accepted across mainstream media (the same media who had prematurely congratulated Ben Bernanke for every gesture). Money markets are again behaving erratically in a way that does not favor anyone.
That’s not to say we should expect a repeat of 2008, or close to that degree of outright panic. On the contrary, bank failures are extremely unlikely. Disorder, chaos and general illiquidity, on the other hand, we already have that. The question now is what all this means moving forward. If these rates continue to dropwe will indeed have a good idea.
And that would be bad.
The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.