The Fed Fires ‘The Big One’

3,676 views | Mar 16, 2020, 12:38pm EST

I identify the pure investment merit of assets with a macro lens.

(PHoto by Galerie Bilderwelt/Getty Images)

Getty Images

The Federal Reserve just did enough to rate a “very happy” by consistent critic President Trump. That alone tells you they fired a big gun. Here are the highlights of the move:

·        Major launch of QE5? The Fed will buy at least $700 billion of Treasuries and mortgages. They will continue to do massive amounts of repo (short-term liquidity arrangements) and let’s not forget all Treasury and Mortgage coupons will buy additional bonds and there will be no runoff of holdings.

·        Interest rates to zero. Party like it is 2011 ZIRP. It took the Fed just two weeks to use up their entire rate cushion that took almost five years to establish.

·        Coordinated swap lines with foreign banks. A technical way to introduce more dollar liquidity globally.

·        Reserve requirements cut to zero. THIS IS THE BOMB!

Going back in all of history, banks have been required to hold reserves against their assets – which are loans and securities. It’s simple – banks set aside a percentage of their assets as reserve and kept it in gold (for most of recorded history) or as cash at the Federal Reserve. This is a fundamental pillar of fractional reserve banking. Conceptually, the reserve gives depositors confidence that when they show up to take their money back, there will be cash to give them. It hasn’t always been nearly enough and if depositors get wary, they “run” to the bank to withdraw their money. Please re-watch “It’s a wonderful Life’ to see what happens during a bank run. It’s not pretty. It hasn’t just happened in black and white either. There were runs in 2007 and 2008 as depositors feared for their funds at several banks.

During the over 100+ years of Fed history, they have mandated the bank reserve ratio. Manipulation of the reserve requirement ratio has been one of their most powerful tools.  That ratio was north of 20% through most of the first fifty years of the Fed (including the great depression). It had made its way down to 10% – that was before today. Until further clarification or notice, banks need not hold any reserve against their assets. This means that banks could theoretically continue making loans to infinity.

Why put this weapon in the payload now? I believe it is a way for the Federal Reserve to deregulate unilaterally without intervention. The Federal Reserve, the FDIC, and other global regulators typically are very specific about the reserve requirements for each risk level of assets. Almost no reserves are required on government bond holdings compared to a much higher level on loans to levered companies. By calling the reserve requirement zero, the regulations become moot. It releases the banks to lend to whomever they want and in any size. This could be incredibly helpful now as levered companies may not have access to the public markets that are wary of the economy. Let’s see if the banks take the actions the Fed is promoting.

What do these actions mean to investors? The actions should satisfy the markets about the Fed’s intentions on liquidity – nearly unlimited. That, in turn, should firm up the government bond markets which were showing signs of malfunctioning late last week. As for the stock market, it is still a dual edged sword. The lower rates are always welcome, but the Fed has shot its biggest weapon and the Fed’s fear may be interpreted as justification of the worst-case scenario. The stock market is too volatile to gauge now; we may have seen peak volatility but what will the reaction be to an unprecedented number of earnings reductions for Q2? Hold your powder for a more observable bottom. The upside of unlimited bank lending will still be there like never before.

Follow me on 

I am the Founder, Partner and CIO of Proficio Capital Partners, a manager of both liquid and illiquid financial assets operating under the direct oversight of family… Read More

I am the Founder, Partner and CIO of Proficio Capital Partners, a manager of both liquid and illiquid financial assets operating under the direct oversight of family trustees and administrators. Most recently I was a visiting Professor at Tufts University teaching Federal Reserve history and policy, and the CEO/CIO of Haber Trilix Advisors. During my 25 years at Fidelity I was CIO (Fidelity Canada), Head of Equities (Institutional), and Director of Equity Research. I have also been a portfolio manager of several equity and balanced strategies. I believe family portfolios need significant diversification and their managers need to understand the correlation, both mathematically and economically, among and between the pieces. Finding value in each separate piece completes the portfolio. I am proud to have been appointed by the Massachusetts Governor, Charlie Baker, to the Board of the Mass Clean Energy Center and I’m a Board member of the Boston Celtics. Read Less