Fed Injects Cash for Third Day as Calm Returns

at Bloomberg dot com. We are seeing the repo rate that got a lot of people all bent out of shape a couple of days ago come down further as a New York Fed engages in a third day of its repo facility, trying to inject calm into this basic plumbing of the financial system. Here joining us, Tom Kennedy, Global head of Macro and fixed Income Strategy at JPMorgan Private Bank. Here in our Bloomberg and Active Broker Studios. Tom, I'm wondering if we could start talking about the takeaways

from this whole episode. Does this mean that the Federal Reserve allowed its balance sheet to just get too small as it allowed it to shrink with quantitative tightening? Yes, yes, all right, So why why the amount of liquidity that a very dynamic US economy needs is impossible to know in exact real time. You can see it and see indicators of a certain amount of excess reserves, which I'm gonna call liquidity for the sake of this discussion, um

that you need for the economy to function. The analogy is that I use this in my own personal life. When I was in college, didn't have a job, wasn't really spending much. My checking account could have relatively small balance in it. It was very small. Trust me. Fast forward, you have a family, you have a job, you have debt, you have more liability needs, and you need to have more cash in your checking checking account. Same analogy can

be applied to the US economy. This economy has grown remarkably over the last ten years, and the repo market signals this week are telling us about one point three trillion in reserves. Is just not enough liquidity. And I'm fully aware of the the technical issues of the supply and demand that happened over the last couple of weeks, But I think we can, for for most people out there, smooth through that and say there's just not enough liquidity

in the system. Despite the popular belief that liquidity is a wash in the system and repo markets. This this week, I've been telling us that the FED comes out with temporary operations. They're just putting cash and liquidity into the system. They this is a temporary fix for a permanent problem. They are going to need eventually to have the balance sheet continue to Expand that's not QUEI, that's just to make sure there's enough liquidity in the system. Shouldn't be inflationary.

If it's not, que how do they do it? Yeah? The good pointly so that the mechanics are the same, but the objective and the end goal are different. In a place where you need to make sure there's enough liquidity, you're injecting just enough to make sure markets function shouldn't be inflationary because you're just making sure you're checking account for the sake of this example, has enough to meet

your demands. QUEI is by even more bonds that are that are necessary for liquidity in the in the attempt to really pull you lower and stimulate inflation. Different objective, same mechanical um implementation that needs to be done. What if the FED decides doesn't agree with you and decides this is just a short term blip. We don't need to do really anything. We don't have to grow this balance too much. Repo rates will continue to remain high. And I mean this week, overnight repo traded north of

nine percent for a period of time. It's quite simple to realize that if you're receiving a yield on an instrument that you own. Let's just say it's a ten year treasury that holds a coupon of two, and to finance that security at nine percent, obviously that's a negative carry position and can't go on for very long. So levered players in a system, if the FED doesn't address this,

will not be able to function. So the FED currently has one point three trillion dollars of non treasury or mortgage backed securities debt that is liquidity for this purpose corrects the excess reserves on the liability on the liability side, or is about one point three one point three trillion dollars? How much should it be? I don't know. I don't think that they know either. I think that all they're

realizing is it's not enough right now. And this is this is kind of the This is where the art of central banking meets what I think is perceived science. Um the economy is so dynamic. They don't know the dot on this dot on this day, we need one point four chilion. They don't know, so they have to feel it a little bit, and the repo market is

sending them a signal they don't have enough. Okay, So the consequences are pretty dire, right that we could end up with a liquidity crunch, even a downturn or some sort of seizure. You know, levered players could get blown out of the water. UH could pull back. This is a private debt, private equity, you know, all sorts of levered currency funds um Looking at that right, I'm wondering on the flip side, the fasure serve comes out starts to buy a lot more bonds that we're just trying

to manage the situation. How do they distinguish that from trying to ease financial conditions. The communication there's a communication challenge with this. This hasn't been a part of their tool kit for ten years. They over the next six eight weeks ahead of the actor re meaning there's gonna you're gonna hear lots of education from them to distinguish the two UH, and that's gonna be vitally important. There is no one in the United States better position to

do this than the New York FED. They're gonna do a great job doing it, but there's there needs to be more education on this, and I expect them to start that as soon as possible. Did you hear anything from Chairman Pal yesterday on that issue? Yeah? I think he. I read him as saying we're gonna learn a lot over the next six weeks as they try to feel where the level of access reserves is required. Um and I also interpreted him as they're going to do a lot of work on how much the balance sheet needs

to grow. And my expectation out of yesterday is that they're going to come up with an announcement in October about how to start expanding the balance sheet again to meet these liquidity needs. Just not do kuwie, just real quick. Giving your experience at the New York FED, do you think that they will get it right eventually or do you think that this will remain a real problem. Confident they're gonna get it right. The team there can do it. I think the art of doing this is is what's

important here. They had to feel where the stress points were I think it caught and by surprise, quite candidly, this came a lot sooner than than myself and I thought then. I think they thought as well, and Powell more or less admitted that yesterday. Um, but they're gonna fix it, and these temporary market operations are vital and they're doing them. But again it's a temporary fix. They need the permanent fix. Uh, and they'll give it to us.

Tom Kennedy thinks so much for joining us. Tom Kennedy's global head of macro and fixing come strategy at JP Morgan Private Bank. Educating us and our listeners on the repo market clearly a challenge head for the Federal Reserve to manage that part of the yield curve is people doubt with our Saudi Arabia really will be able to bring all their production back online all that soon. The

question is how much higher will it go? Joining us now, we are so pleased to say, Bob Ryan, she's trying to just focused on commodity and energy strategy for b c A research. Bob, where do you think the price of oil is going? I'm looking at crude on then IMEX right now at fifty and sly three cents of barrel. Yeah, thank you for having me. UM. That's tough to say. UM. You know, we're UM right now trying to figure out how fast storage is going to be drawn while Saudia

is repairing Opcake. Mostly we did some scenario analysis just at the margin, not saying this is where UM prices are going to go. But you know, the marginal impact of UM delays in bringing these facilities back online UM could push you, you know, through eighty dollars UH in the first half of next year. So UM. That's not

to say it will happen. UM. What most likely happens is commercial inventory keeps drawing down and at a certain point, if you know, we see the forward curves in crude oil, the Brent and the w t I start to really backwardate, UM, that'll be a signal or an indication that UM spr barrels are probably going to be needed. UM. And you know it wouldn't surprise me at all if the d o E in the US is keeping track of that. UM. You know what's happening to the evolution of the curve.

You know, if I'm looking at Brent right now, it looks like the curve is steepening just a little bit as the market works through this. So I think that's the big thing to start keeping track of m as we go to the end of September, when you know, the Aramco folks have been saying that, um, you know, the repair should be mostly done. You know, markets waiting

and waiting to see what happens. But my expectations we do see storage start to draw, prices move up backwardation, Uh Stevens, So, Bob, what is what do you think the market is kind of discounting today about maybe an escalation even of tensions between Iran and Saudi Arabian perhaps the U S. I know it's you know, almost impossible to handicap, but do you think the market is expecting this thing to get maybe even a little bit worse

it could? Um, you know, our our assumption is is that the Trump administration is going to more than likely retaliate in some form militarily, but not in a way that escalates this to a full out you know war between the US and Iran or between the US and it's GCC allies and Iran. UM more than likely. Um, you know, it's it's going to be a message it's

not going to be um, you know, a declaration of war. Um. It's interesting also the Iranian foreign minister I saw a headline going across was saying that any attack on Iran itself would be or would result in all out war. So that you know, both sides are are as. We that in our morning meeting this morning. Um, you know, there's there's a lot of loud barking on both sides, but um, we don't think it escalates to that extent.

But you don't know. I mean that the big thing with these kinds of confrontations is that, um, you know, they could spin out. You know, you could have inadvertent um uh you know, consequences that quickly get out of control and and and the hard thing is containing it. Uh, you know, once you set something in motion. Well, so let's talk about sort of the asymmetric risks associated with a potential conflict over the escalation that we've seen with Iran.

How high could oil prices go versus decline if there is no conflict, if it gets resolved, if Saudi Arabia gets the production on board, and things just chug along the way they had been. Um, you know, prices would be probably fairly well contained, and then you know, you'd go back to the OPEQ plus or what we call OPEC two point oh UM managing production trying to you know,

get control of the storage levels globally. UM. The eighth symmetry is if you do get something, um, you know, some kinetic activity between uh, you know, the US and Iran, just as an example, that threatens the street of hor moves, then markets would really start to price in you know, large price moves to the upside. UM. If we uh see this thing resolved and you know, we go back to status quo ante as it were, UM, you know, we probably come back down to you know, holding around

this year, you know, maybe into the seventies next year. UM. You know, a lot of it depends on what happens to the UM production management of OPEC plus and the impact on demand. UM. As we move forward, high prices will oil sequel h more than likely start destroying demand, particularly if you get a dollar rally on the back of that, you know, everybody uh flies to safe havens,

the US dollar being one of them. That'll effectively raise the local currency cost of oil around the world outside the US, and UM, you'll get demand destruction on the back of that. So you'll have high absolute prices in US dollars, but you will also have high local currency prices, and that will start to a road demand and and

the higher goes the more significant that erosion will become. So, but before the attacks on the Saudi facility, I think the narrative in the in the oil market was people really focusing on demand and what a slowing global economy means for oil putting some pressure on on crude. What does your demand model say, you know, you know, x out some of the concerns in the Middle East. Yeah, if we just you know, take our base case, you know,

exactly as you say, X that out. Um, you know, our expectation is that demand this year grows on average like one point two million barrels a day, So we're a little above the I E A. And I think the E I A is probably at about one million a day. Next year, we're at one point four one point five all l sequel, Right, you know, we we

get this massive fiscal and monetary stimulus globally. Um, you know, it revives demand, it starts to it not starts to it undoes a lot of the uh tightness and financial conditions that were brought on by the FED tightening cycle last year, as well as the d leveraging campaign in China which took a lot of liquidity from the system. So those two things we're just starting to show up or had started to show up, you know, in second

half of last year, first half of this year. That should be undone with all that stimulus coming into the system. So we would be much more bullish demand growth next year as all the stimulus comes in. But you know, we are in uncertain territory here. Yeah, very good, Bob, Thanks so much for joining us. Bob Bryan, chief Strategist Commodity and Energy Strategy for bc A Research, giving us

his thoughts on the global oil market. Obviously a tremendous amount of volatility experienced over the last week or so given the attack on the Saudi facility and what that means for the supply side of the equation. So to get some more data there, we welcome our next guest, automan A Zilder, Senior Director Economics and Global Research Chair at the Conference Board. Automan he joined us in our Bloomberg Interactive Broker Studio. Thanks so much for coming in

what is your data telling you? I know you've reported the data for August. Good morning, great to be here, thanks for having me. And um, the ALII for August just came out, and as your viewers listeners now that the ALII is a forward looking gauge of the economy, and in August it remained unchanged. So what's the implication, I mean, is that good, bad, or just basically just

don't even think about it now? So the ALII trends have been kind of flattening, um, and they're still rising around the same level as earlier in the year, but not as fast as we had seen in the previous years. So that just tells me that we are settling into a slower growth economy. Uh, kind of going back to the long term trend? What is the long term trend? Kind of from your perspective. So at the conference board, we estimate that long term trend to be right around

two percent growth. Okay, So right now, as we look at the economy, look at all the data that's coming out and even some of the micro data we see from companies and earnings and so on and so forth, the US economies seems to be a story of Okay, manufacturing not so good and maybe even worrisome not so good, but the consumer is still very strong. Is that kind

of what your data is showing you. That's essentially what we see in the leading indicators to when you look at the households and consumers, they're kind of holding up the economy. But when you look at manufacturing, new orders and manufacturing, especially for capital goods, there's a lot more weakness that's kind of holding the index down. One thing that's kind of interesting, we keep getting a positive reads

on housing data today. Another one with used sales, used home sales coming in stronger than expected and as one part of the leading economic indicator. That is one area that's that was sort of a big positive, right, a big contributor. Yeah, housing permits made a positive contribution to the index, and that is good news for the economy because housing overall is a leading sector for the overall

US economy. But jobless claims was a negative contributor. And I want you to talk about that since we do talk at the consumer kind of holding up the entire expansion here, is that sort of a warning sign, right, So the consumer of obviously is uh supported by the good jobs growth and where we would be worried if that's going to be changing. And the leading indicators for employment have started to soften, and unemployment claims is one

of those. So it's not really surprising to see some softening in the labor market um, but employment is still growing and that's supporting jobs, income and consumer spending. When do you when does your data, you're leading economic indicator start flashing a red sign to you when you see multiple months of declines, is it is what's kind of

the big flash point for your indicator exactly. So what I'm looking for in the leading indicators is where whether it's falling consistently over several months, it's a gauge of future economic activity that's six to nine months ahead. And the peak in the leading index forms on average about twelve months ahead of the economy turning down. So that is the leading relationship and uh, so far we're not really seeing that sort of a peak forming in the

leading indicators. So I'm looking right now and many Roman, the CEO of PIMCO, said that he expects US growth to hover slightly above one percent for the first half of which is substantially lower than it is currently do you think that's plausible based on these indicators. So the indicators are really consistent with the economy slowing um just around two percent, So that's a little more pessimistic than what we're seeing in sort of the fundamentals of the economy.

A lot of people are nervous about the future because they look at interest rates yield spreads, but that's really only one part of the leading indicators, uh, and it's not really widespread across other components. So it's perhaps a little bit more pessimistic than what the leading economic indicators may show. Adamana Aziel Durham, thank you so much for being with us, Senior director of Economics and Global Research at the conference board, joining us here in our Bloomberg

Interactive Broker Studios. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts or whatever podcast platform you prefer. Paul Sweeney, I'm on Twitter at pt Sweeney, I'm Lisa Abram Woyd's I'm on Twitter at Lisa abram woits one before the podcast. You can always catch us worldwide on Bloomberg Radio.