18 September 2019

Market Commentary: ETH recovering & FED intervenes in the USD Overnight Repo Rate

Patrick Heusser

Patrick Heusser

Senior Trader at Crypto Broker AG

About the author

I have two topics on my radar today: ETH and the USD Overnight Repo Rate.

Let’s start with ETH.
I have to admit, I am surprised by the strong recovery of ETH versus BTC, but also versus USD. The market has seen a constant buying interest for the past 2-3 weeks.

I have had various chats with other brokers and dealers around the globe trying to figure out what is going on. There is no clear consensus. But what can be said is that some big accounts and funds, which were short ETH, started to cover their positions. Additionally, various analyses have pointed out that exchanges have a net outflow of ETH, which means that there are clients physically buying ETH and transfering it to their own wallets (this is typical behaviour for hodlers). We have received similar feedback from OTC desks, which mention that the sentiment has changed from selling to buying ETH, with not a lot of two-way interest.

In my opinion, these circumstances have led to the recovery of ETH prices against various other currencies. It did catch me on the wrong foot, however, and I have closed my shorts in the Altcoin Future Index.

What is going on in the USD Overnight Repo market?
First of all, most of the “non-financial” people out there do not know what that is, which is totally understandable as it has nothing to do with their everyday life nor is it an instrument like the Dow Jones or S&P Index, which receives wide and daily media coverage.
But for financial professionals who work closely with the FED or any trading desk that operates in the interest rate sector, this is a very important instrument. I will come back to the reason why later.

The main purpose of this Overnight Repo market is to steer or distribute the remaining liquidity that is in the system to the banks and financial companies who need it on a very short-term basis (overnight trades are basically your last chance to lend or borrow money in case you have not squared your account balance – if you miss it, you could end up being short on your account, which is a “no go” according to the FED).

The FED is trying to estimate the needed amount of cash that has to be in the system so it works smoothly. If some unforeseen event happens such as the downfall of Lehman Brothers, they can trigger their emergency facility to inject cash into the system by their so-called “Overnight Repo Operation”.

They have injected $53 billion to calm down the market. The stress is/was visible by a very high overnight repo rate. It hit 10% on Tuesday where the normal trading band was between 2% and 2.25%. Click here for more.

For example, Blackstone’s vice chairman, Tony James, sees this as simply a technical issue that can be fixed by the FED, and that is the reason why such overnight repo operations exist. He claims it is just an overnight rate, hence if the FED gets it back down to more normal levels the real economy will not feel that rate shock at all.

But as a reminder for all of you younger folk out there who were not sitting at a trading desk during the Lehman Brothers downfall, I can assure you that this Overnight Repo Rate is absolutely crucial for the financial market. If the money stops flowing the system comes to a full stop and a brutal financial system breakdown will be the consequence.

I am definitely not in a position to tell you why this happened. There are far more specialised people out there who also say they are not sure why it happened (e.g. Jim Bianco).

But there are some possibilities that I personally believe could have played a part in it, which also have some further implications to the arguments out there as to why hold bitcoin versus Fiat currencies.

To me, it looks like we had a few issues happening all at once. Firstly, there are those corporate tax payment days that usually have a cash draining effect on the system as all US-based firms will pay their taxes, which drains liquidity from the banks. Normally, this is not an issue, as the Fed is accounting for those events and making sure there is sufficient liquidity in the system.

Additionally, we have the US government, which widens its budget deficit continuously. Simply stated, to fund that deficit the government has to issue US Treasury bonds. Those T-bonds need to be bought up by the primary dealers (big US banks directly connected to the Fed wire). But to do that, those banks need cash. Since there is a cash shortage, which is expressed in a spiking Overnight Repo Rate, the Fed injects cash.

In the early days, this was called QE, but they did it on the longer end of the curve – more in the 5y and 10y sector and not overnight.

As Cabana, a Bank of America analyst, pointed out, the FED will not call this QE, though he said it will work the same way. The central bank will grow its balance sheet by purchasing Treasury bonds. The Fed won’t admit this, but it looks and smells an awful lot like the monetary authority is financing the fiscal authority.

Bam! A further devaluing of Fiat money! To me it feels like there has been no way out of this heavy increased money supply since 2008, and that central banks have no tools left, or room to manoeuvre, except to try to kick the can down the road a little further every day. But for how long can they do it, and what will happen if they stop doing it?

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