Some Behind The Scenes Stuff

In a November 2021 note, I introduced the notion of?T-Fed:

?

"In March of 2020, in an effort to help 'manage'?the economy and markets through 'tough times', the Federal Reserve effectively joined forces with the Treasury... creating an entirely new entity out of thin air, and behind closed doors. Some wonks have taken to calling this?new?alliance between the presumably independent Fed and a clearly partisan Treasury, "T-Fed".

M'kay.

This new?(unholy) alliance?proceeded to check off a laundry list of new programs.?First off, let me emphasize that the initial emergency?measures put a stop to the market panic; a good thing.?Since then, though... not so much.?

With the benefit of hindsight, their policies slashed?interest rates (to negative in real terms), which both reduced debt service costs and?encouraged the use of leverage;?put cash directly into consumer's pockets (Stimmys, PPP), which not only maintained but in many cases substantially improved pre-pandemic income levels; and levitated?asset values (via QE), which buoyed consumer balance sheets (at least those with financial assets... ESPECIALLY those with the most wealth).??All of which combined to generate an unimaginable mountain of cash, which juiced?demand growth into the stratosphere."?

?

Okay, fast forward to last?week... an interesting?one for?T-Fed, which?has continued its symbiotic relationship for 4+ years now.? Treasury announced both their new Buyback Program and their Quarterly Refunding Announcement (QRA), while the Fed announced the?tapering of QT followed?by Chair?Powell's very dovish presser.

And the thing that links all of last week's moves?? No, it's not politics (much); it's the methodical/inexorable march by fiscal/monetary policymakers to keep the leverage-funding markets free-flowing... and more regulated.

Our financial system runs on leverage. Lots of it.? And Treasury securities?are the collateral of choice for many key leverage-providers (lenders).? Rehypothecation?of that collateral is what juices the returns from leverage.? However, taken to an extreme (think 50-100x-leveraged), Treasury rehypothecation risks creating, um... 'plumbing accidents'.? A number of such accidents have occurred in the repo markets since the GFC... and they weren't pretty.?

Last December, these periodic market?seizures spurred policymakers to make sweeping changes to the funding markets, with a specific focus on getting repo transactions centrally-cleared through an exchange (where they can be better regulated).? Currently, the?vast majority of repos (and thus, Treasury rehypothecation) are done off-exchange, in a corner of the unregulated 'shadow banking system'.

All this behind-the-scenes-maneuvering, when combined with further looming rule changes coming?from the?'Basel III Endgame',?are clear attempts by policymakers to (i) make the all-important funding markets more resilient, (ii) regain better knowledge of/and control over how (and how much) leverage is created, and (iii) to re-impose oversight/regulation onto the majority of the current credit-creation process that had moved?outside?of the traditional banking system after the GFC.??

It could also be setting the stage for traditional banks to once again serve as storage facilities (along with the Fed's balance sheet) for all the Treasurys that will need to be issued/absorbed to?keep our stimulus-addled economy on its feet.?

And they say history doesn't repeat.?