A debate over a sudden dramatic surge in Repos is raging. Is it or isn’t it QE4?
Organic Growth
On October 9, Powell discussed “Organic Growth” of its balance sheet.
“Going forward, we’re going to be very closely monitoring market developments and assessing their implications for the appropriate level of reserves,” Powell said at a news conference. “And we’re going to be assessing the question of when it will appropriate to resume the organic growth of our balance sheet.”
Not QE
On October 10, Powell commented on Not QE.
“I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis,” said Powell.
“In no sense, is this QE,” Powell said in a moderated discussion after delivering his speech.
Quacks Like QE
Peter Schiff chimed in what what I believe to be the consensus view: Powell Can Call It What He Wants, But It Quacks Like QE
As the reliable American folk wisdom states: if something “looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.” In this case, Powell can call the new Fed program anything he wants, but it certainly quacks like QE.
Hussman Sides With Powell
In One Tier and Rubble Down Below John Hussman made the case that Powell is correct.
There’s a broad misunderstanding that the Fed’s recent repo operations somehow represent “quantitative easing in disguise.”
Not quite.
The essential feature of QE was that the Fed purchased interest-bearing Treasury bonds, replaced them with zero-interest base money, and created such a massive pile of zero-interest hot potatoes that investors went absolutely out of their minds to seek alternatives, resulting in a multi-year bender of yield-seeking speculation.
With that understanding, it should be clear why the Federal Reserve’s recent repo facilities do not, in fact, represent a fresh round of QE. The difference is that the repo facilities replace interest-bearing Treasury bills with bank reserves that are eligible for the same rate of interest. This swap does nothing to promote yield-seeking speculation. Now, the psychology around these repos has certainly been good for a burst of investor enthusiasm and a nice little can-kick. But that enthusiasm isn’t driven by actual yield differentials – as QE was – it rests wholly on the misconception that these repos themselves represent fresh QE.
Balance Sheet, Monetary Base, Excess Reserves vs QE
To better understand and explain what Hussman is saying, I created the above chart.
I based my QE boxes on Yadeni Chronology of Fed’s QE and Tightening.
Hussman mentioned “Treasury Bonds” but the Fed bought various durations. I used the 10-year Treasury Rate as a proxy in my chart.
If one wants to nitpick, zero-interest base money is not perfectly accurate as interest on excess reserves was slightly above 0% as shown by the green line.
That tiny correction aside, the Fed did suck up bonds yielding over 3% at time and replaced then with reserves yielding just over 0%.
As Hussman points out, someone has to hold those cash reserves at all times resulting in the “hot potato” environment in which those earning 0% desperately tried to get rid of the cash.
This only “worked”, using the term loosely, because asset prices were rising. If at any time, asset prices fell for a prolonged period, cash at near-0% would not have looked so bad.
Effectively, with its policy, the Fed blew another massive bubble.
Just Don’t Call it QE
Subadra Rajappa, head of US rates strategy at Société Générale, also sides with Hussman.
“That’s the distinction between QE and just increasing cash reserves in the system. It’s a communication challenge. It’s a very nuanced difference which could easily get lost,” said Rajappa as quoted by the Financial Times.
Organic Growth
Let’s return to the top.
If you accept what Hussman is saying, this isn’t QE, but is sure the heck cannot be called “organic” growth either.
Organic growth looks like slow upward movement in monetary base, not the explosions in monetary base and asset growth