DoubleLine on Fed, Money Markets
Bond fund manager DoubleLine posted the paper, "Quantitative Tightening Risks Decoupling Money Markets from Fed Funds Rate." Written by Bill Campbell, Co-PM of DoubleLine Global Bond Strategy, the strange piece says, "Fixated on Federal Reserve interest-rate policy, the risk markets could be missing 90% of the monetary iceberg: the Fed's $3.8 trillion balance sheet and the more than $3.3 trillion U.S. money market. A decade ago, the central bank embarked on so-called quantitative easing (QE), bond-buying on a colossal scale to flood the banking system with excess reserves and avert a meltdown of the financial system. Now, with the U.S. economy showing years of continued improvement in employment, the Fed has reduced excess reserves. This effort at policy normalization is tightening financial conditions. Such quantitative tightening (QT) is at odds with recent signals by the Fed of its intent to ease official short-term interest rates. This policy divergence poses two threats. First, QT could choke off credit just as the U.S. is entering an economic slowdown, raising the odds of recession. Second, QT could derail the Federal Funds rate as an effective monetary lever. Indeed, signs of 'Fed Funds' losing its efficacy are already appearing in the overlooked but vital money markets. In fact, money market rates could decouple from Fed policy actions. Such a development would jeopardize market confidence in the Fed's ability to transmit monetary policy to markets, threatening a major risk sell-off." Campbell concludes, "I believe the Fed's reduction of excess reserves in the system is reaching a limit beyond which our financial institutions will enter increasingly turbulent waters within the money markets. Therefore, the Fed should cease its liquidity-draining efforts. Arising out of the wake of policies by the Fed and the broader government, these troubled seas have the potential to swamp the economy and financial system and blunt the Fed's principal tool: the Effective Federal funds rate. The Fed currently plans on ending QT by the end of this September. Let's hope that comes in time to avert striking the monetary iceberg."
