Well, we came within three basis points of a second “Fed Red Day” yesterday, September 18, when the Fed lowered interest rates and no one saluted (markets fell rather sharply, then recovered).
If you are new to Critical Signals Report, we describe Fed Red Days here.
In short, Fed Red Days occur on days that the Fed lowers interest rates (that’s good news), but markets close lower (that’s bad news). Good news is supposed to take the markets up… not down.
Down is red – it means your stock investments probably lost money on a day that the Fed lowered rates – hence “Fed Red Day.”
So here we are, almost two Fed Red Days in a row. Good news that generates a bad effect has historically marked important turning points in the markets, indicating that a recession is imminent or may already have begun – long before the NERB informs us.
A Close Call
Fed Red Day #1: On July 31, 2019, Powell’s Fed lowered rates by 25 basis points. That’s supposed to be good news. Markets should have gone up… except they didn’t. By the end of that day, the S&P 500 Index fell 1.09%, the Dow Jones Index fell 1.23%, and the Nasdaq Composite Index fell 1.18%.
Close Call – Fed Red Day #2: Yesterday, the Fed lowered rates again, by another 25 basis points, to a range of 1.75%-2.00%. Stocks markets opened down and fell further on the 2:00 p.m. news to a loss that briefly reached the largest in four weeks, before recovering with the S&P 500 Index up just three basis points. The Nasdaq closed down 11 basis points. It was a raucous day in the markets, worthy of your attention.
Fed Red Days forewarned of the past three recessions (well before the NERB informed us), namely before (1) the Oil Price Shock Recession in the early 1990s was announced, (2) before the Dot.Com Bubble Recession in the early 2000s was announced, and (3) before the Great Recession of 2008-2009 was announced.
Here’s what the Fed didn’t address in its official remarks yesterday, but did mention (and downplay) in Powell’s less-formal remarks to the press following the 2:00 p.m. news release.
And this is more important than a Fed Red Day…
Fed’s First Money Market Intervention Since the Financial Crisis
Earlier on Wednesday, ahead of announcing the rate cut, Federal Reserve traders jumped in to rescue the U.S. money markets to stop key short-term rates from spiking by injecting $75 billion of liquidity to calm money markets down. No mention in the Fed’s official remarks is disturbing to us, given its importance.
For the first time since the financial crisis, the effective federal funds rate had trounced the Fed’s target rate:
A quick primer may be in order here on how this works.
The federal funds rate is the interest rate banks charge each other for overnight loans to meet their reserve requirements. It comes in two flavors: The “target” federal funds rate is the rate set periodically by the Federal Open Markets Committee (FOMC). That’s rate that the Fed set yesterday.
The rub here is that the Fed cannot force banks to charge the Fed target rate. Rather, banks negotiate overnight rates among themselves, resulting in an “effective” federal funds rate.
When the bank-driven effective rate gets out-of-whack with the Fed’s target rate, the Fed can jump in (as it did on Wednesday) to lower the effective rate to its target rate by adding liquidity, which it did, by $75 billion. (Conversely, the Fed can withdraw liquidity if it wants to raise the effective rate to a higher target rate.)
Fast forward to today. The Fed intervened yet a third time, with an injection of another $75 billion, raising to $203 billion the sum of all injections over the past three days. To boot, the Fed signaled its willingness to do “whatever it takes” to tame the markets – a line we’ve heard before from ECB head Mario Draghi.
The objective in all of this is to quell money-market stress. U.S. funding markets are on edge as excess reserves in the banking system dwindle.
Hate to say it, but we’ve seen this movie before.
Looking back (charted below), repo rates soared ahead of the Great Recession… then tumbled as the Fed stepped in. We’re in a lower interest rate regime this time around, with rates well below rates just before the financial crisis, but the chart does rhyme. Just saying…
The federal funds rate is the most influential interest rate in the nation’s economy. It matters that the Fed has to jump in (especially repeatedly) to rescue its target rate because that means the market (the banks) are in control, not the Fed. That’s a concern. Once, okay… fine. Continued chaos in the short-term funding market, though, would be more systemic, more recessionary.
Let’s take the logic one step further. At some point, injecting liquidity like this could become a fool’s journey, as the banks take short rates up as fast as the Fed takes them down. The bottom line here is that there may not be enough liquidity in the system to satisfy demand, making the Fed’s job that much harder.
It’s Time to Take Action
With these kinds of recession indicators in full view and liquidity issues rising, it’s time to take action. I’ll be telling you just what to do in Friday’s column.
I’ll be back with you soon.
7 responses to “Why Yesterday’s Almost “Fed Red Day” Should Still be on Your Radar”
September 19 2019