Comments (2)

  1. Gordon Hally says:

    How is the Fed “steadily draining US dollar liquidity from the global financial system”?

    1. Lindsay Hall says:

      Gordon,
      Thanks for the question. In order for the FED to raise rates, and keep them there, they use reverse repos to drain liquidity from the system. To give a little background, an example of a repo transaction would be a bank not having enough cash on hand to make a loan. The bank can lend another party (usually another bank) collateral (typically high grade bonds) in exchange for that cash in order to make a loan. The bank takes the cash, makes the loan, and eventually will buy back the bonds at a slightly higher price (the other bank makes a small profit). Banks exchange in these types of transactions daily, and repo’s are a major element of daily liquidity. Reverse repos would be the exact the opposite. The central bank opening its reverse repo program essentially gives commercial banks the opportunity to lend the FED cash in exchange for the bond holdings where the commercial bank makes a small profit. This drains liquidity from the financial system, and reduces the amount of cash on hand to lend. In order to incentivize the commercial banks to actually lend to the real economy loan features needs to be sweetened. This is a key reason why credit spreads (corporate borrowing costs) have widened, which is another element of FED policy leading to tighter financial conditions. The reverse repo program, which you can view on the Federal Reserve website, has increase significantly over the last 18 months, which has drained liquidity from the system. If the FED continues on its tightening campaign, and continues to use the RRP tool, it will continue to drain US dollar liquidity.
      -Evergreen Investment Team

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