If it sounds like there’s a squeaky faucet getting tightened, you’re not hearing things. Liquidity is going to start becoming a rarer commodity.
Honestly, I should’ve spent more time discussing this. Because interest rates are at the heart of almost everything in the capital markets. But with all the attention on sovereign credit risk, commodities, and currencies, nevermind the regulatory stuff, it’s hard to maintain focus in this Ricochet Rabbit day and age we live in.
But let’s refocus. Over the past month, there has actually been a lot of activity out of China in stemming the tide of excess liquidity. It all started shortly after the first of the year, which I covered here. A 4.04 basis point upside surprise in yield on 3mth bills caught investors off-guard. Happy New Year, folks.
The next week, China raised the yield on its 1yr securities by 8.29 basis points, which signaled to the market their intention of guiding yields – and thus rates of return – higher. In doing this, the Chinese are looking to slow the deployment of capital, and slow growth.
But that’s not all. There’s the 50 basis point increase in reserve requirements that the banks must meet.
The Chinese are much bigger users of reserve requirements than other countries, but as the People’s Bank of China explains it:
The PBOC considers reserve requirement adjustments a ‘fine-tuning’ of existing monetary policy rather than any shift in its overall stance. Raising the ratio is aimed to prevent the excessively fast growth of monetary and credit aggregates. Lowering the ratio is aimed to ease credit.
So as you can see, the push to drain liquidity is on.
But for all of the liquidity draining going on in China, the real question is what/how the liquidity drain setting to commence here will affect the markets. As was pointed out in various places, today saw the end of a multitude of Fed liquidity facilities. From today’s Real Time Economics blog:
Today, much to the Fed’s relief, several of these programs were put to rest and nothing bad happened. Stocks and Treasury bond prices rose.
The programs produced an alphabet soup of funny names, like the Commercial Paper Funding Facility (CPFF), Primary Dealer Credit Facility (PDCF) and Term Securities Lending Facility (TSLF). For the most part, the programs did what the central bank was designed to do when it was created in 1913 — act as a lender of last resort which provides emergency credit to firms during a liquidity crisis. And as it promised it would do last year, the Fed has stopped doing them now that the markets have calmed.
This is one exit strategy Mr. Bernanke can check off as being executed fairly seamlessly.
Indeed. However, the folks at Real Time jumped the gun in calling the exit a success. Hell, to even call any of those programs successful is to not know the definition of success.
I mean, does this look like a success?
And the PDCF: of the primary dealers it was intended to help, one was taken under, one went bankrupt,and the other was merged into a bank. These are not stellar marks.
But the real issue, the success of the exit, can’t be determined yet. For your consideration, I offer two charts: one of the daily standard deviation in Fed Funds, and the other is the daily quote of the effective Fed Funds rate, but with a twist I’ll explain later.
Let’s look at the standard deviation chart:
I circled the area post fall ’08 for a reason. Remember, this is a measure of the daily standard deviation, which is an expression of volatility. Notice the dampening after the Fed’s switch from declaring a target rate to a target band. The effect? Brings the vols way down.
To look at it in a different light, consider the next chart,which shows the daily effective Fed Funds rate. But I also layered in the high and low measure of each day’s Fed Funds trading, because there’s a point I want to make:
Note the high and low at the left. Now compare the way that part of the graph looks compared to the right. The volatility has been brought way down, and the only thing worth asking is this:
How long can that last?
We’re going to find out…