EFF-IOER: What's Next?



Same as  Cackalack Capital, this is my first post. I joined the troops after MM asked for some help. I am honoured and thrilled to get the chance at it. Please feel free to contact me with any questions, comments, ideas at macrodiver1@gmail.com.


Alongside the wild ride in Libor-OIS, which was the subject of a Cackalack post, something on my radar and somewhat less discussed, apart from some short end nerds like myself, is the narrowing of the EFF-IOER spread ( Effective Fed Funds -Interest Rate on Excess Reserves) . 


For almost all of 2017 that spread was at 9 bp. Then coming into the FOMC December 2017 meeting it started to tighten. Of course this is moving at a snail pace but a move from 9 bp to 5 bp in about 4 months for something that didn’t move for 18 months prior to that is entitled to raise a few eyebrows. 


Some would say the Fed started shrinking its balance sheet in October last year and this is draining reserves, putting upward pressure on the Fed Funds rate. That's true but... In October excess reserves were 2.12 Tn, in December it was 2.19 Tn, so this explanation doesn't hold for the December move. It now stands at 1.99 Tn, it’s starting to bite and will more so in the future as the balance sheet reduction accelerates (see graph below). 

Another culprit could be the diminishing weight of the standard FDIC assessment charge but here again we are talking pennies. The weighted average was 4.4 bp in Q2 17, 4.2 bp in Q3 17, we don't have the numbers for Q4 yet but even tough banks capital improvement will drive it lower it's unlikely to be the catalyst.

What about Bills and Bonds issuance ? As we can see from the chart below, the Treasury cash balance started to move up in December and has been on an accelerating path since then. This is due to the large Bill issuance that started then and accelerated after the US budget was voted in early February. It is now sitting at 414 bios, over the Treasury projection of 360 bios for end of June, certainly aided by this month tax receipts inflows. 




The Bill issuance is also draining reserves and alongside the increasing Bond issuance it has an other side effect. It creates upside pressure on  GC overnight repo rates. As a proxy I'm using the GCF Index as longer history for SOFR and BGCR are not yet available. As we can see below the 5days moving average GCF - IOER spread has tightened from -7 to +1 in the last 2 months. A correlation with Tbill outstanding seems to exist.   This is changing the relationship between the various overnight rates and in my view is the main driver behind the move higher in Fed Funds.



This month the Treasury has slowed down Bill issuance due to the tax receipt inflows but they will ramp it up again in May.   The Fed has also increased the passive balance sheet reduction from 20 bios to 30 bios/month at the beginning of April (it will be 40 bios from July and 50 bios from October). This 2 factors let me believe the Effective Fed Funds Rate has not finished its march higher and we could see it getting nearer the IOER rate in the coming months.

Good luck,

MD



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checkmate
admin
April 27, 2018 at 9:41 AM ×

Thanks ,very nice first post. Appreciated.

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Cbus20122
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April 27, 2018 at 9:39 PM ×

Great post!

My notes / thoughts on the markets at week's closing.

1. I feel like the rally yesterday and to a lesser degree, today was relatively weak considering how strong earnings were for most of the Fangs and other stocks. It's good for owners of these stocks that they performed well, but I think the bigger worry is how bad industrials looked this week. Industrials are often the first to get hit during a slowdown since their businesses are the first to be affected by things like higher rates, higher costs, and weakening global demand. Tech, especially on the b2b side can post great results even as the economy is getting constrained. Digital advertising won't get affected until ad budgets get cut, which probably won't show up in any quarterly report for at least 1-2 quarters after a slowdown realistically starts to happen.

2. On that note, I think the biggest near-term risk (or rather, trigger) is Apple's earnings. Just about all of Apple's suppliers posted bad guidance, and I think Apple posting bad earnings will be an easy trigger for another selloff.

3. I mentioned earlier in the week that rates were rising at the same time that yield assets were (REIT's utilities, etc). Yield assets did well all week, and the flattener resumed after nearly hitting 3.05%. I didn't think we would go over 3% so easily, but I've seen some mention that 3.05% is the real resistance level to look out for. So far, that seems to be true, but we will see.

4. As others have noted on here, the most important thing in the markets is the dollar right now. If the dollar keeps rising, nothing else will matter, especially if it does so in tandem with interest rates. Another thing worth mentioning is that higher dollar is notably bad for tech since they are so heavily involved in international markets. Specifically, Apple and semiconductors are not well positioned here in my opinion.

5. Going along with rising dollar, the other real thing that matters way more than you would expect given how little attention it's getting is overall dropping liquidity. Rising Rates + Rising Dollar + Decreasing Liquidity + Record Debt + Record valuations. That is literally the basic formula for creating a recession on a fundamental level. Right now, we're just in the process of awaiting conditions to tighten to a level where they truly start to cause problems and defaults.

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Leftback
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April 30, 2018 at 4:34 PM ×

SPX bumped up to 2683 and was rejected. There is the possibility that it breaks through the 50 day at 2687 today or tomorrow and has a run at the top of the range, currently around 2700. That would be a great fade, the bottom of the range is the 200 day at 2612. Good AAPL results + Goldilocks jobs data = 2700. Bad AAPL + inflationary data = 2612. That more or less bookends the week's outcome.

Another great day to do nothing but watch. Mainly AAPL flirting with the 200 day, as we witness Act One of what may become a legendary piece of Pump and Dump. AAPL rose for two trading days before the Feb 1 announcement and then hemorrhaged 6-7% in two days - in what was at the time a Teflon equities market.

A very interesting piece of market manipulation by AAPL today, announcing a massive giveaway to shareholders, e.g. a one-time dividend deal. Their aim here is three-fold: to clean out a decent number of shorts ahead of earnings if they can, to suck in unwary buyers, and to distract from what might be a big earnings miss. One has to say this smells of desperation, and the usual response to this kind of C-suite prank will be a spike after-hours followed by the inevitable sell-off on guidance. If they were sandbagging ahead of what are actually decent numbers they would be quiet in order to slaughter the maximum number of shorts and there is no way they would be making these kind of noises. Perhaps they could hire John Sculley for the day, as a bit of nostalgia, just to announce the bad numbers and then do the call?

Not tempted to play AAPL directly - but given its importance to the index ETFs, the finger is definitely near the SELL button. One obvious support level for AAPL is 150, the next one is about 142. Nobody expects to see that in a one day move but we could potentially see such a drop evolve over 3 or 4 days. 150 would be a 10% drop in the largest stock in the SPY. Let that sink in... if this scenario plays out in full, no way the SPX hangs on to the 2600 level, and new YTD lows are a definite possibility. Not a high probability - but not out of the realm of possibility given current market structure. Now that the warmer weather is here Wall Street will be looking to shear some sheep before the summer doldrums.

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Cbus20122
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April 30, 2018 at 10:11 PM ×

I think the markets have been setting up a selloff on Apple. Lots of somewhat negative stuff surrounding Apple right now regarding future guidance, which isn't the best sign either.

On a technical note, SPX had a real ugly close + an outside day.

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May 1, 2018 at 10:09 AM ×

If I tip you anything.....its this. I got out Apple shares a long a time ago. Make that the tech sector. If uni teaches you anything....it teaches you what you don't want to do with you life. Then you can move on and focus on better probabilities out there and fun!

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Cbus20122
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May 1, 2018 at 3:48 PM ×

Interesting thought, and this may be irrelevant by the day's end, but as it stands right now, SPX is sitting on an island reversal once again. If it doesn't break above the 2643 gap, then we'll close the day with a full island reversal.

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Nico G
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May 2, 2018 at 1:34 AM ×

while everyone in yield land seems to obsess and debate endlessly over the significance of govies flattening,

Charles Gave looks at the private sector curve:

https://www.zerohedge.com/news/2018-05-01/i-expect-financial-accident-occur-gavekal-reveals-new-flashing-red-warning?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29

super informative

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zh jin
admin
May 2, 2018 at 4:07 AM ×

@cbus,

Nice timing on your SPX argument. Good job!

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