Stocks Flat on Eurozone Recession Fears; Fed Committed to $1 Trillion Liquidity Injection

Stocks gained early and faded late as poor economic data from Europe dampened the mood on Wall Street at the start of the last week of the third quarter.

Eurozone manufacturing PMI fell to 45.6 on Monday, the worst reading in nearly seven years, with the German manufacturing PMI falling to 41.4 in September from 43.5, the worst number since the fall of Lehman Brothers sparked the global financial crisis.

The poor figures sent European stocks reeling, fearing recession, especially in Germany, Europe's powerhouse, could be right around the corner. US indices were less-affected, though the Dow Industrials was the only index to post a positive close.

At the same time, the US banking system was being monitored, as the Fed continued its series of repo auctions. In this statement from the New York Federal Reserve, the central bank committed to 1.05 trillion in overnight repo auctions through October 10, and at least an additional $90 billion in two-week term repo auctions.

The sudden appearance of repo auctions, with the Fed buying back treasuries or MBS in exchange for ready cash from (supposedly) primary dealers has economists on edge, especially considering the huge amount of excess reserves clogging up the system.

Those not so alarmed point out that these extraordinary repo auctions are the result of a highly-predictable cash crunch for banks as corporations tax payments are due at the end of the quarter. This causes a drain on the system overall, though there was no need for such measures since the Lehman debacle a decade ago.

What happens next in markets is probably more volatility and sideways trading due to uncertainty. Recession fears in the Eurozone are probably real, though the US may actually be in good enough shape to avoid a significant downturn through 2020. The Fed has cut rates twice this year after raising them by decidedly too much. Political forces are bound to keep the Fed honest and operating largely at the behest of the markets and President Trump, who has loudly criticized the Fed's step-behind operations.

At the Close, Monday, September 23, 2019:
Dow Jones Industrial Average: 26,949.99, +14.92 (+0.06%)
NASDAQ: 8,112.46, -5.21 (-0.06%)
S&P 500: 2,991.78, -0.29 (-0.01%)
NYSE Composite: 13,085.33, -8.47 (-0.06%)

Weekend Wrap: Cash Crunch Easing, Though Culprits Remain Anonymous

Ending a streak of three consecutive weekly gains, all major US indices took an about-face when Friday's quad-witching day sent stocks South.

Losses were not large, though they were widespread, as fear of a looming recession and confusion over the Fed's four straight days of repo auctions took away market enthusiasm.

Make that five straight days, as the Fed held another $75 billion repo auction on Monday, prior to the opening of equity markets in the US. Signs that the cash crunch was easing, only $66.75 billion was accepted as collateral by the Fed, making the auction officially undersubscribed.

On Friday, the Fed had also announced that it would conduct overnight repo auctions every day until October 10, and additionally would provide three 14-day term repo operations for an aggregate amount of at least $30 billion each, Tuesday, Thursday, and Friday of this week.

While nobody is certain which banks - or single institution - is having a hard time balancing its nightly books, any sense of panic has been effectively blunted by the Fed's actions.

As markets open the final week of trading for the third quarter, it will be instructive to note how markets respond, especially on Thursday and Friday. With the close of the quarter, some firms traditionally buy stocks in favor, as so called "window dressing," though it appears that this quarter might have a wholly different tone, given the stress in the system.

In what could be a most important week for markets, any words from Fed speakers should also be quantified in relation to ongoing cash shortages and the global condition.

At the Close, Friday, September 20, 2019:
Dow Jones Industrial Average: 26,935.07, -159.73 (-0.59%)
NASDAQ: 8,117.67, -65.21 (-0.80%)
S&P 500: 2,992.07, -14.72 (-0.49%)
NYSE Composite: 13,093.80, -17.50 (-0.13%)

For the Week:
Dow: -284.45 (-1.05%)
NASDAQ: -59.04 (-0.72%)
S&P 500: -15.32 (-0.51%)
NYSE Composite: -30.54 (-0.23%)

What the Heck is Phugoid Dollar Funding and Why Does It Matter?

So far this week, markets have encountered a major disruption in oil supply, an interest rate cut, three repo auctions, and the usual assortment of nonsense from Washington, DC.

Through all that, stocks have barely budged, leading up to a quad-witching day on Friday, with multiple options and futures expirations expected to add some volatility to the week. If it goes anything like the prior four days, the week will end with a thud, rather than a bang.

After the Fed's unsurprising announcement to lower the federal funds rate 25 basis points on Wednesday, a third straight repo auction was held Thursday morning, offering cash settlements on another $75 billion in collateral, mostly Treasuries and MBS.

While the repos signal some cash flow issues for some unidentified primary dealer banks, cause for the cash shortfall has not been ascertained.

Perhaps, as described in the link below, it is a case of Phugoid Funding, a condition which matches up pretty well with the current out-of-kilter global economy.

In an incredibly prescient post - although from April, 2019 - from Alhambra Investments (some of the brightest minds out there) about what is happening with the ongoing liquidity crunch that has the Federal Reserve conducting three consecutive repo auctions (Tuesday, Wednesday, Thursday), Phugoid Dollar Funding is explained in detail with an explanation of how it applies to current economic conditions.

At the Close, Thursday, September 19, 2019:
Dow Jones Industrial Average: 27,094.79, -52.29 (-0.19%)
NASDAQ: 8,182.88, +5.49 (+0.07%)
S&P 500: 3,006.79, +0.06 (+0.00%)
NYSE Composite: 13,111.25, -8.05 (-0.06%)

Fed Cuts Rate, Markets Slightly Bearish Initially

Initial reactions to the Fed's cut of 25 basis points on the federal funds rate announced Wednesday afternoon were unusually bearish.

Not only did stocks sell off - only to be rescued by mysterious bids in the final hou of trading - but so too crude oil, gold, silver. Bonds languished, with the 10-year note down a single basis point to 1.81% yield, though shorter maturities sold off, the two-year note gaining five basis points, from 1.72 to 1.77%, threatening to invert with the 10-year again.

One-month bills reacted naturally, with yields dropping from 2.10% on Tuesday to 1.96% on Wednesday's close.

Rumors of the Fed announcing a restart of QE were dismissed. The federal funds rate was lowered to 1.75-2.00%.

The vote was seven for the cut and three against. Voting against the action were James Bullard, who preferred at this meeting to lower the target range for the federal funds rate to 1.50 to 1.75 percent, a 50 basis point drop; and Esther L. George and Eric S. Rosengren, who preferred to maintain the target range at 2.00% percent to 2.25 percent.

The FOMC's penultimate meeting for 2019 is scheduled for October 29-30.

Considering the volatility in bonds and the unusual repo auctions held the past two days, market reaction was rather muted and refined overall. No panic was seen, though some degree of caution was notable.

At the Close, Wednesday, September 18, 2019:
Dow Jones Industrial Average: 27,147.08, +36.28 (+0.13%)
NASDAQ: 8,177.39, -8.63, (-0.11%)
S&P 500: 3,006.73, +1.03 (+0.03%)
NYSE Composite: 13,119.31, -12.09 (-0.09%)

Anticipating Federal Funds Rate Slash, Fed Conducts Repo for Cash-Strapped Banks

In case you missed it, on Tuesday, the Federal Reserve conducted a repurchasing event - known in the business as a "repo" - to inject cash into the system, which had run low on reserves.

Essentially, the primary dealers, among them the nation's largest banks, found themselves a little short on cash and needed to sell some bonds back to the Fed. In all, the Fed took back $53 billion and the system survived a rare liquidity crunch. It was the first repo auction since the great Financial Crisis of 2008.

This kind of activity may not be so rare going forward. The Financial Times reports that the Fed is holding another repo auction on Wednesday morning, offering up $75 billion in cash in exchange for various types of bonds, most typically, Treasuries or Mortgage-backed securities (MBS).

What triggered the double-dip into repo-land is the unusually high volatility in bond markets, which have been whipsawed of late. The benchmark 10-year-note, for instance, has yielded as low as 1.46% and as high as 1.90% just this month, and currently sits at a yield of 1.81%. The high rate at which bonds are turned over by the primary dealers and others may have left some banks upside down, or wrong-footed, this week.

The second repo has taken place, ending before 8:30 am, Wednesday morning.

The results were less-than-encouraging going forward. The auction was oversubscribed by $5 billion, meaning somebody has a short-term cash flow problem. The Fed offered up $75 billion and $80 was bid, so somebody didn't get what they were seeking. $5 billion is a lot of money, no matter how you slice it. This is going to show up somewhere and it won't be pretty. Prepare for bank failures at an increasing rate.

Otherwise, the markets stay relatively calm on the surface, with futures modestly in the red. At 2:00 pm ET Wednesday, the FOMC will announce their policy directive, ending a two-day meeting. They are widely expected to decrease the federal funds rate by 25 basis points, from 2.00-2.25 to 1.75-2.00.

If the idea of a range, rather than a distinct point for the federal funds rate seems different, it is. The Fed used to just set the rate at a distinct point, like 2.50%, but now they issue a range. That change occurred in 2008, when they dropped the rate to zero, or actually, 0.00 to 0.25. The Fed didn't like the rate being exactly zero bacuse that would have sent a bad signal, so they changed to a range.

What really happened is that the global fiat currency economy broke in 2008. ZIRP and the various forms of QE were bandages when a splint and a cast were needed. The system is still broken, moreso than in 2008 and the injury, once a break, is now amplified with a fever, an infection, and the hospital is out of meds.

Tra-la-la.

At the Close, Tuesday, September 17, 2019:
Dow Jones Industrial Average: 27,110.80, +33.98 (+0.13%)
NASDAQ: 8,186.02, +32.47 (+0.40%)
S&P 500: 3,005.70, +7.74 (+0.26%)
NYSE Composite: 13,131.41, +23.43 (+0.18%)