The Fed’s printing press, which has been booming since the markets crashed last spring, has drowned the American banking system in liquidity.
As the Fed is pumping $ 120 billion into the markets every month, buying back government and mortgage bonds, banks have a surplus of liquidity, which they cannot find any better use than returning it back to the Fed at 0% per annum.
The volume of reverse repo transactions, in which banks and money market funds “park” free “cash” in the FRS, continues to break historical records.
On June 9, 59 participants placed $ 502.9 billion overnight at the Fed, according to data from the Federal Reserve Bank of New York.
Back in mid-March, the demand for such deals was zero. By the end of April, it reached the level of $ 200 billion, on May 20, it exceeded $ 300 billion, and at the end of the month it exceeded $ 400 billion.
There is so much dollar liquidity in the system that it has turned into “hot potatoes that no one wants to keep,” says Andreas Steno Larsen, strategist at Nordea.
A paradoxical situation has arisen in the market: the FRS “prints” dollars and buys out government bonds, and banks return these dollars and take government securities from its balance sheet that have become scarce on the repo market.
“The more money you put into the system, the more you get back,” says Lou Crandall, chief economist at Wrightson ICAP. “The market says enough, QE has gone too far.”
In a little more than a year, the Fed increased its balance sheet by $ 3.5 trillion, and in total the world central banks pumped $ 10 trillion into the markets.
BofA estimates that another $ 3 trillion will be added this year to the liquidity tsunami that pushed stocks to historic highs and pushed commodity markets to 10-year highs.
In addition to the FRS, the US Treasury adds dollars to the system, which actively spends the funds accumulated in its accounts, said Padriac Garvey, head of research on money and debt markets at ING.
Starting the quarter with $ 1.045 trillion, the U.S. Treasury spent more than $ 300 billion by June 8 on community disbursement programs and state aid.
This money settled in the banking system, and there was so much liquidity that it simply had nowhere to go, says Garvey: “Reverse repo from the Fed is not where you would like to park cash, given that the rate is 0% per annum.”
The Fed continues to argue that it is too early to roll back quantitative easing, but markets are increasingly worried about inflation, which is hitting records in decades by some metrics.
The Bloomberg Economics team has brushed the dust off a scientific model from former Federal Reserve Chairman Ben Bernanke and used it to assess the outlook for U.S. inflation. The results suggest that consumer price growth will hit 4.8% year-on-year in May, and hold at that level – a record since 1990 – until the end of August.
According to Nordea’s forecast, inflation in the United States may reach 7-8% levels in the summer, which will be the highest since the early 1980s.
Investors are preparing for the Fed to move to tightening policy in the second half of the year, and the economy will turn from inflation to stagflation, that is, a situation where prices will rise against the backdrop of declining economic activity, analysts at Bank of America write.
That is why, BofA notes, large funds are building up their cash reserves, adding them to money market instruments, where $ 84 billion was invested in the last two weeks of May.