It seems central banks the world over are dogged by their respective repo (repurchase agreement) markets. So much in the financial system and asset classes is linked to this very market that Wall Street firms and banks sell U.S. Treasuries to raise collateral and cash to finance their overnight trading and lending facilities. This is crucial for maintaining liquidity in the financial system and when banks do not hold sufficient reserves, they are short of dollars or liquidity, and the system freezes up -- causing a spike in overnight term rates, as we saw back in September 2019.
This spike was reminiscent of the spike in October 2008, prior to Lehman Brothers collapsing, and so shockwaves were felt across the U.S. Federal Reserves and they have gone full gangbusters opening taps to avoid any shortage of liquidity. The key problem is that the world, including banks and now Hedge Funds, are so levered that rates cannot afford to rise even in the slightest. Despite regulation, leverage takes different forms and wealth is created to boost returns. We all know how and where it is done, but no one has the guts to stop it.
Quarter-end and year-end tend to cause severe spikes in repo markets as banks have low reserves and higher payments and tax commitments, along with all the levered bets they take. Q3 2019 saw the Fed come to the rescue and start balance sheet expansion followed by the famous not-QE QE and pumping of $500 billions of dollars in the form of overnight repos to keep the system in check.
It seems China, too, is facing a similar destabilizing liquidity hole of 2.8 trillion yuan ($400 billion) in January, according to local securities firms as people withdraw money going into the lunar near year holiday. The Peoples Bank of China is expected to ease aggressively in the coming weeks by cutting reserve requirement ratios, injecting funds via overnight repos, or even a benchmark interest rate cut to bridge this gap into January 2020.
On Wednesday, the PBOC injected about 200 billion yuan in liquidity via overnight reverse repos (their equivalent of a U.S. repo) after doing nothing for 20 sessions. It also lowered the rates on the 14-day repos from 2.7% down to 2.65%. On Thursday, they injected another 250 billion yuan in liquidity via 14-day reverse repos. They have now added the most cash in overnight markets since January this year, and we all know how domestic markets and risk assets rallied aggressively on their gargantuan liquidity injection in Q1 2019 to offset the horrid slowdown of Q4 2018.
In a recent economic assessment, China just maintained their annual GDP growth of 6%. We all know that that means an average of 6% as clearly the economy is growing a lot less than that, so they need to do something to prop up the average. What is the best way to get that number up and fast? Infrastructure spending.
Chinese local governments have launched 1 trillion yuan in infrastructure projects in December, driving up prices of cement and construction materials. This is a lateral boost for copper as copper is one of the key items used in "infrastructure" and construction. On December 18, China's southwestern province of Sichuan announced 1405 infrastructure projects involving a total of 724.4 billion yuan.
Copper is one of the tightest and most-balanced commodities out there. Companies have not invested in large projects and growth is set to come from a handful of companies over the next few years. The global slowdown of 2018 has hurt copper demand as Asia and China have come to a halt. Even then, copper never fell below $5800/tonne.
The Trade Deal shenanigans have continued to keep a cap on prices, too. That hurdle has now cleared. If trade and demand picks up even the slightest, as we see evidenced by PMI and Manufacturing data showing a small uptick, copper prices are set to rise even higher. According to International Copper Study Group (ICSG), copper mined production has fallen 0.5% this year. Mine capacity utilization has risen 5% from 81.4% to 86.2%. If infrastructure demand picks up, that will give rise to copper demand. A market like copper is balanced in a recessionary world. What happens when you light a series of matches underneath a flammable material, figuratively speaking that is?
Central banks around the world are pumping liquidity into year-end and the new year like there is no tomorrow, literally. One can be cerebral about Fed policies and their inefficiencies, but liquidity is the key indicator that drives asset prices. It seems the U.S. Fed and ECB will no longer think of raising rates until inflation is much higher. That is their only agenda.
As long as central banks are stimulating to stave off a repo crisis, the market is in the "show me the growth" phase and the data is getting better -- a self-fulfilling prophecy. When the Fed and central banks stop the money gravy train, then we can see where things stand. For now, just follow the money, the rest is simply noise.