Moving Slowly
Quiet. Very quiet.
Tuesday's equity markets. The day prior to Fed Day. Broad market indices all moved slightly higher. More narrow measures covering small-caps and transports saw mild contraction. There was an eerie feel to the marketplace on Tuesday.
Ever try to move through a wilderness environment swiftly but silently? So quiet that the animals don't see you coming? Snap a twig or kick a rock. Uh oh. Stop. Get real low. Wait for a reaction from the wildlife. Wait some more. Then even wait some more. Move out again. Not so swiftly this time.
Just like that. Only futures markets trading in Chicago did move quite a bit. Indeed, the probabilities of any reduction to the fed funds rate in Wednesday afternoon's Federal Open Market Committee (FOMC) policy statement moved back and forth around the 50/50 mark. Still, most traders do expect a cut of 25 basis points here on Wednesday. Or maybe they hope. At least that much is seemingly priced in, with both the S&P 500 and Nasdaq Composite retaking their respective 50-day simple moving averages (SMAs) in September, then solidifying those gains in the wake of the European Central Bank (ECB) policy decision made last Thursday, the 12th.
Liquidity Question
What happened this week in overnight money markets? Why was such a big deal made of spiking overnight rates that forced the New York Fed to impose control in order to bring these rates back down to the high end of the Fed's stated targeted range? Let's simplify.
Bear in mind that overnight lending markets, or meeting extremely short-term needs for cash, are what keep the economy moving without visible hiccups (real important to keep this market free of trouble). The thing that happens is that market participants enter this market looking to both borrow and lend in order to satisfy those overnight needs. Early Tuesday morning there was real friction in the gears. In other words, the need for short-term cash outpaced supply, forcing what is known as the "repo rate" to spike before being brought back into line.
The question is, why did this happen after a decade of not needing the New York Fed to get involved? Can it happen again? What can be done?
Several factors did converge to cause a short-term lack of liquidity. For one, Monday was quarterly tax day for corporations and for folks (like me) who run their own businesses. It is common for pooled cash to land in short-term money market funds as tax day approaches. Then, like magic, poof!! It's gone. That is one possible reason for a lack of cash, but hey, this happens four times a year. It's not like you don't see the headlights in the distance.
Now, there are other, better reasons for a short-term liquidity mismatch. For one, recent -- and now larger --issuances of U.S. Treasury debt securities amounting to $54 billion of newly auctioned assets faced settlement needs in recent days. So, on the surface, like two ships passing in the night, it would look like supply and demand timed exposure poorly through no fault of their own.
Structural Question
The far deeper question, and one you will hear asked of Fed Chairman Jerome Powell on Wednesday, will concern quantitative tightening, or the reductions made to the Fed's balance sheet just ending. We know that at the height of the "quantitative easing" era that U.S. banks held nearly $3 trillion in excess reserves with the Federal Reserve. This summer, that total had dwindled to something along the lines of $1.3 trillion.
How much in aggregate excess reserves are necessary? According to the Financial Times, the Fed does not quite know. A paper published by the New York Fed suggests a minimum level of $1 trillion. Also from FT, in 2017, Lorie Logan, head of market operations and market analysis at the New York Fed, said in a speech in 2017 (and, wow, do I love this) that we'll know that level when we see it.
Psst.... I think we see it.
Solutions
The thing the New York Fed did, in effect, was to inject $53 billion into the banking system through these already mentioned repurchase agreements on Tuesday morning and state a willingness to inject another $75 billion if need be on Wednesday morning. That $53 billion number is awfully close to the Treasury number. Hmm.
Now this ad hoc solution has brought overnight rates back in line with target, but there are better, firmer solutions than waking the NY Fed up when liquidity surprisingly runs dry.
The Fed could lower the interest rates paid on excess bank reserves, known as the IOER, which currently is at 2.1%. Lowering this rate could be a tool used to manipulate all short-term rates as well as manipulate the effective fed funds rate within the targeted range.
The Fed also could set up a more permanent repo facility rather than needing to react to news like this in what appears to be a rush job. That seems like a no-brainer, and also seems incredibly irresponsible that something like this was not already set up. I mean, gee whiz, what the heck are you here for?
Lastly, and this is where DoubleLine Capital's Jeffrey Gundlach went on Tuesday: The Fed could decide to start growing the balance sheet again. Make no mistake, the $53 billion repo operation executed on Tuesday does grow the balance sheet (more than a month's worth of QE at the height of those programs), as would the $75 billion limit for a similar operation on Wednesday.
No, I do not expect the FOMC to launch a new quantitative easing program Wednesday (this) afternoon. I do expect the financial press to bring the idea up, however, and put Chairman Powell in an awkward spot early in the press conference.
Increased Treasury issuance is expected to continue. Obviously, the need for a certain level of aggregate excess reserves held at the Fed is a little higher than previously thought and will only grow. This has to be on their minds at the FOMC. In the meantime, how about a nice standing repo facility? This is not exactly rocket science, gang.
Just Thinking
Now that the New York Giants no longer intend to start their aging Super Bowl winning, future Hall of Famer at quarterback and the New York Jets have lost two quarterbacks in two weeks, is it even possible that these two struggling franchises are not working out some kind of short-term solution of their own? Again, this is not rocket science, gang.
Space Mountain
I am sure many readers have enjoyed the Space Mountain attraction at the Walt Disney Co.'s (DIS) theme parks. Those who haven't might try trading crude oil futures as one way to experience all that a roller coaster in the dark has to offer.
Shortly after the aerial attacks on what is the core of Saudi's energy production infrastructure, Bloomberg reported that Saudi Aramco, the state-owned business, feared that full recovery could take months. This, coupled with rhetoric around the issue that sounded like saber rattling, caused a rush on those future markets that seems likely to have been exacerbated by a short squeeze.
One day later, Prince Abdulaziz bin Salman, Saudi Arabia's energy minister, indicates that oil supply could be back on line sometime this month. Down goes Frazier. Down goes oil. Down goes the sector.
Like I have told you before, there is still plenty of risk here. To Saudi Arabia? Sure. To really anyone? Yeah. Bad people do bad things.
I own the oil names I own for the revenue they provide. I don't often trade the names, though I do manipulate net basis as often as needed. This has kept these positions from staying negative for very long. The thing a retail investor can do is separate this portfolio from a core book. Open a new account if need be, if one does not like the potential drag on the profit-and-loss statement.
Nothing stops the retail investor from holding several isolated portfolios, each with a different mission statement (write the darned statement). You think at the big brokerage houses that the same prop trader or analyst covers more than one sector? More likely there is a head trader for each sector who has multiple assistants. Yes, much more is required of those who run their own show. Still, there are steps that can be taken to effectively aid the brain in compartmentalizing the thought process. The whole ball of wax at once can be intimidating, especially for those who do something else occupationally. You can do this. Better than that, you can do this for yourself.
Possible Breakout?
I have seen several articles in recent days covering bomber aircraft. So much news swirls in this space. The future in strategic bombing lies in the stealth B-21, a futuristic project the contract for which has been won by Northrop Grumman (NOC) . Air Force simulations show the need for these aircraft at greater than the 80 to 100 bombers originally thought. The very first flight for this craft is currently scheduled for late 2021. For those wondering, both United Technologies (UTX) and BAE Systems (BAESY) are significant subcontractors for this project.
Development costs for the B-21 are estimated at more than $23 billion and there is talk of retiring the B-1 Lancer just to free up funds in order to increase order size for the B-21. That said, remember, the U.S. is basically the only world power capable of bring this kind of heat. There is potential for a gap in mission capability in between a possible retiring of the B-1 and a mission-ready B-21. That's where extending the life of the incredibly old, and yet incredibly effective, B-52 Stratofortress comes in.
A contract to replace the entire fleet of B-52 jet engines valued at between $5 billion and $7 billion is expected to be awarded to a single manufacturer by the end of next year. Just for your information, leading candidates for that job appear to be General Electric (GE) , United Technologies and Rolls-Royce (RYCEF) .
The thing I see in this chart is a name that has run an incredible 53% year to date, even beating the 50% run made by Sarge fave Lockheed Martin (LMT) . However, NOC has just spent the month of August digesting these 2019 gains. Now, the shares stand back at the top of the chart, just below an obvious pivot, with Relative Strength looking sharp and with a daily moving average convergence divergence (MACD) on the verge of a bullish crossover.
Should the shares take and hold this pivot, NOC could still have quite a ways to go, at least technically. I would not move on these shares with geopolitical concerns running hot, especially if one has enough exposure to the industry, and especially with an FOMC policy decision expected later this day. But on a failure here at pivot, who would not want another swing at this pitch?
Economics (All Times Eastern)
08:30 - Housing Starts Aug): Expecting 1.249M, Last 1.191M SAAR.
08:30 - Building Permits (Aug): Expecting 1.3M, Last 1.336M SAAR.
10:30 - Oil Inventories (Weekly): Last -6.912M.
10:30 - Gasoline Stocks (Weekly): Last -682K.
The Fed (All Times Eastern)
14:00 - FOMC Policy Statement.
14:00 - FOMC Economic Projections.
14:30 - FOMC Press Conference.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (GIS) (.77)
After the Close: (MLHR) (.78)
