I recently had a back and forth with the twitter account @stimpyz1, who I can only assume is a guy that’s definitely “in the know” via the economy, monetary policy, and financial plumbing, and colleague of Danielle DiMartino Booth. A highly recommended follow, needless to say. You can read my thread here.
It’s clear that under Powell’s regime for US monetary independence, a new system is being built out that will severely impact how treasuries, and markets in general operate. Specifically, Margin regulations. No longer will you be able to post junk as collateral for treasuries and leverage them to the hilt under ZIRP. This is completely in line will Powell’s policy of Higher For Longer, in order to drain the offshore dollar system/credit markets that has distorted America’s economy and funded the deterioration of society by the powers that be.
So how exactly does this work and what will be the implications? Thankfully for you, I’ve made a breakdown.
Leverage Go Bye-Bye
From fear of treasuries going bid-less like they did during COVID, the Fed is increasing their demand via new SEC regulation of mandating that brokerages require traders us treasuries as supreme collateral. This ends (in some sense, but not entirely) rehypothecation of treasuries, or puts on restrictions. MEANING:
1. You won’t be able to post junk as collateral to get treasuries,
2. You have to go through the Fed’s central clearing house system
3. No longer can you rehypothecate treasuries, lever them up, we’ll Return to full margin (unclear on what this means exactly)
What does this do?
1. Raise the demand for treasuries
2. Force treasuries to “go to ground” and absorb their flow
3. Create bid that wasn’t there before so it doesn’t go bidless again.
This looks like: Traders will post REAL collateral against their trades, and not have to explain why they can’t pay back the treasury they borrowed if their other counterparts went tits up and lost it.
The normal flow of Shadow Bank Trade roughly resembles something like:
1. Trader goes to broker and posts junk for treasury
2. Trader trades treasury for cash with counterparty
3. Takes cash to make other trade hoping to make enough spread to pay back cash counterparty, his original broker, and then pocket profit
This works assuming nobody’s caught short in their derivative position or hedge book blows up. New regulation gets rid of this “pass the baton” bull shit.
Plus on the flip side, as BRICS sell treasuries for dollars, the bid to offset that demand will come from the US because they’ll be forced to buy those treasuries in order to use them as collateral. And meanwhile, BRICS will replace treasuries as their “piggy bank” with gold, and also trade in gold which will send gold higher.
For the sake of redundancy, the newly forced increase in demand in treasuries in US will flatten the curve on the short end, and BRICS selling of treasuries will increase in the long end. Thus, the yield curve will be flattened. Severely limiting rehypothecation of treasuries will force purchase of treasuries to act as hard collateral for trades. This will force more true market-driven risk pricing not only into leverage and carry trades, but the rest of the economy.
Credit Deflation, Commence
As far as equity markets are concerned, my GUESS is the cliche “only the strong survive.” That might be more companies than we think if stocks have lasted this long, but honestly who knows.
Let’s not forget that because banks aren’t flocking to the BTFP because they have to pay it back at prevailing interest rates AND raise capital, that’s why your credit union and banks in general are off ring you 4+ whatever %. As Tom Luongo has said, “they want your funds” in order to buy new treasuries to fill the holes on their balance sheets. So that might cushion the banking industry.
There’ll definitely be credit deflation in the most levered areas of the economy, primarily CRE as well as the new supply of residential waiting to hit the market. After that correction, this opens up the opportunity for “deals to be made” in the private credit market as I’ve discussed in past articles such as this one below 👇
If you want a sneak peak (shout out to Dom) of what credit deflation might look like, look no further to trucking. This is exactly what could happen all throughout the world over the next 1-2 years. Thanks to higher rates, all of these venture backed companies that were running a year over year deficit as a company and just going out and getting a new round of investment from venture funds.
Private Equity won’t have the monopoly over these market deals anymore since they’ve been wiped out via rates and lack of hedging. This ultimately is the result of higher for longer: true price discovery from honest actors making real investments in the each other as they fill the holes of their balance sheets.
Rewriting America’s Monetary Constitution
I composed a thread earlier this week further detailing the the rogue monetary policy Powell is taking, specifically the re-indexing of US debt from LIBOR to SOFR. LIBOR was the ball-in-chain American was burdened with when it came the offshore credit creation which distorted and wrecked our markets. This thread further emphasized exactly how and why Powell is rebuilding America’s financial and monetary rails for the nation’s sovereignty.
Firstly, the Eurodollar market is/was NEVER decentralized, as many in this space proclaim it to be…at least not it’s indexing rate (the rate those dollars are priced at).@SantiagoAuFund and @HodlMagoo’s premise assumes the Eurodollar market was decentralized to begin with. This is just incorrect. Plus Magoo claims SOFR is “centralizing of control of rates.” Sorta, but some context is def needed regardless.
So, let’s sift through the nuance.
The Eurodollar market was priced in LIBOR until last year, 2022 with SOFR. Only under Trump’s appointment of a Powell-ran Fed was this even possible. SOFR has been shot down for over a decade by globalists like Bernanke and Obama. More on the politics of SOFR vs LIBOR next…
The Fed didn’t control its monetary policy under LIBOR, the City of London did via a captured market of central planning/globalist-minded banks. It was a manipulated/unsecured rate. Now the Fed controls monetary policy/ dollar price with SOFR, a secured rate based on the US repo market. So in this context, the eurodollar was NEVER decentralized under LIBOR nor SOFR. The US controls the price $ are issued, not some globalist offshore banks based on a manipulated unsecured rate. The US’s domestic repo activity is what collateralizes SOFR. That’s the nuance.
LIBOR was artificially dictated by central planners at the City of London by 18 panel banks (only one of which represented the interests of the US, being the JP Morgan branch in London). It was basically decreed like fiat. To say the least, it was scandalous and problematic.
It’s important not to get it twisted with Jeff Snider’s theory that the Eurodollar is a “decentralized/free market response” to the Fed’s centralized control of monetary policy. That argument is bunk, naive at best, disinformation/a psy-op at worst, and far from “free market.”
So basically, now the US controls the price of all dollars being issued around the globe thanks to SOFR. And for the risk of being redundant, the difference is that SOFR is actually based off of something. ie collateralized by the domestic repo market in the US. You may still be asking “yeah, Phil. I GET that part, but what of the actual the distribution of euro dollars (offshore dollars)?” The majority of dollars are offshore…That’s why it’s called the offshore dollar market… Below is a chart from JP Koning of @BullionStar.
This is bc the US: 1. exports its inflation 2. Gave dollar reserves to offshore banks and accepted their Eurodebt, or other sovereign debt from Europe that was, wait for it, basically junk as collateral. J.P. Morgan stopped doing that in 2019, which Martin Armstrong has pointed out, is what caused the repo spasm that fall before COVID.
And why exactly did that repo spasm/credit crunch happen? WE WERE STILL INDEXED TO LIBOR!!! Meaning when a credit spasm happened over seas in Europe, we felt it too. Why? Our debt was indexed to the same ball and chain as Europe (LIBOR). America was forced to socialize FOREIGN losses. If their rates went up, so did ours. Meaning we’d feel it in our debt: credit cards, auto payments, etc. Now that we’re on SOFR, that doesn’t happen.
Now, our monetary policy/price of debt/interest is independent from the rest of the world. THAT is precisely why SOFR is the official Declaration of Independence from the British crown because the City of London longer controls our monetary policy. America does. Now, the dollar price can’t be made free to fund wars. Our monetary policy is America First. Thanks, Powell.
RRP “running out” FUD
There has been Fed criticism by the likes of Lyn Alden and others (rightly so), about the Fed’s reverse repo (REP) facility running out. Since Powell raised this rate 5 basis points above the Fed Funds Rate in 2021, it drained the globe of approximately $2 Trillion dollars of base money and has been operating as a piggy bank for investors since they were able to get more yield on their cash than what the market offered.
Now since the Fed has been raising rates, that money has been gradually leaving the RRP for newly issued treasuries and is projected to empty the facility by Spring 2024. That money simply will go into the money markets/back into the economy towards companies that are credible/left standing after the zombie companies that were backed by offshore credit finally collapse.
Critics of Powell’s policy are also falling short in another aspect. They assume there’s no:
political revolution happening (Matt Gaetz going against the uniparty).
And
A possibility the Fed’s balance sheet starts shrinking, which it will as QT happens in the background every month
The debt doesn’t have to be 0, it just has to show signs of improvement. That’s enough to send global capital running into the US, especially with a normal yield curve. That’s how you taper the US ponzi. Optics. Thanks to Powell’s policy of Higher For Longer creating a more credible Fed and economy under a new systematic and structural revolution, we get to see the change happen in real time.
Finally, there’s more clarity and certainty in the SOFR futures curve when Powell will pivot. With enough economic cushion from the above events, Powell will be in the position with a new financial system and enough ammo to cut rates without breaking the foundation of the economy, resulting in a “soft landing.”
The economic changes under the hood clearly demonstrate that America is changing how markets function for good. For once, we’re actually seeing proper regulation being put in place that protects the little guy. Free money begets stupid ideas, which begets a corrupt society. Powell’s Higher For Longer monetary policy is ridding us of this chaotic market landscape that was going off the rails on a crazy train, and paving the way with sounder infrastructure for a much more transparent, fair and scenic ride. Grab your tickets.
~ Phil Gibson
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