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Against the backdrop of an imminent interest rate cut in the US financial market, the market is not calm. A series of recent events have plunged the United States into a sharp volatility and liquidity crisis. First of all, on the eve of the upcoming publication of the minutes of the meeting, the market ** financial markets will be volatile; Second, the market is concerned that the first day of the new year saw a double kill of stocks and bonds, which means that the previous interest rate cut expectations may have been too aggressive. Most critically, there is a so-called "money shortage" in the US market, with a reduction in liquid cash and a shortage of money in the market, which also triggers a possible credit crunch. As a result, there is a suspicion that the Fed will stop shrinking its balance sheet at a critical moment to avoid further losses to the market.
What is causing the liquidity crisis in the U.S. financial markets? The main reason can be started with the Fed's policy. At the December 2023 interest rate meeting, Fed Chairman Jerome Powell announced that he would pause interest rate hikes and keep the U.S. federal interest rate at 525%-5.5% level. The dot plot released later hinted that the Fed would cut rates three times in 2024, bringing rates down to about 4Around 6%. The news led to the strengthening of US Treasuries, with the 10-year yield falling to 39% or so. This sharp drop in yields means that there is an increased demand for the purchase of U.S. Treasuries, which have gone from being unpopular to being an investment-worthy variety. As a result, investors have recently become more enthusiastic about buying U.S. Treasuries, and even a lot of liquidity has shifted to buying U.S. Treasuries.
However, this situation poses a problem. A healthy financial market usually has a relatively abundant pool of idle funds to cope with a possible credit crunch. However, a number of factors have led to the dwindling of these idle funds. If this problem is not addressed, the U.S. financial system risks falling into a liquidity crisis and major problems. Currently, the US is in the latter stages of its rate hike cycle and lacks liquidity support.
1.As the Fed continues to raise interest rates, it is now at the point where interest rates are at their highest and there is no time to cut them. This means that liquidity in the U.S. stock and bond markets is also close to recent all-time lows, when there is the least amount of money in the market. According to the Federal Reserve's overnight reverse repo agreement facility data, the current liquidity in the reverse repo market has increased from 2$55 trillion has been reduced to about $704.9 billion now, and the relevant interest rate has remained at 5Around 38%. Market liquidity continues to decrease.
2.A large amount of capital flows into the ** and other *** trading markets. The expectation of a Fed rate cut in 2024 will keep the dollar lower, while dollar-denominated rates will, making buying as reliable as buying U.S. Treasuries. Since there is such a large amount of money flowing into the purchase of government bonds, then just as much, if not more, money will flow into the ** market.
3.Access to U.S.** and other bond markets. In addition to Treasuries, there are other** bonds and bonds with high credit ratings available in the U.S. to invest in. The yields on these bonds are generally better than those of U.S. Treasuries, so in the case of bullishness on the bond market, some funds will also be allocated to other types of bond markets to lock in the current about 55% high yield.
In addition to the liquidity crisis, the US financial market is facing another important issue, the impact of the Fed's balance sheet reduction. In the aftermath of the financial crisis, the Fed stimulated the economy by buying large amounts of Treasuries and mortgage bonds and increased the size of its balance sheet. However, as the economy recovers and inflation rises, the Fed has begun to reduce the size of its balance sheet to avoid possible inflationary pressures and asset bubbles.
The Fed's balance sheet reduction has been achieved primarily by stopping the reinvestment of maturing bonds and mortgage bonds. This means that when bonds mature, the Fed no longer reinvests them with new bonds, but removes those maturing bonds off the balance sheet. As a result, the Fed's assets will gradually shrink.
However, the Fed's balance sheet reduction has had a certain impact on market liquidity. Balance sheet shrinkage can lead to less liquidity in the market, especially in the face of other liquidity pressures. This could lead to higher market interest rates, a credit crunch and increased instability in financial markets.
To avoid this from happening, there are a few things the Fed can consider. First, the Fed can adjust the pace and size of its balance sheet reduction program to better align with market liquidity conditions. Second, the Fed can take steps to provide temporary liquidity support, such as injecting liquidity through reverse repo operations. In addition, the Fed can also work with other banks to deal with liquidity pressures and financial market instability.
In general, addressing the liquidity crisis in the US financial markets and the impact of reducing the balance sheet is a complex task. The Fed needs to carefully consider various factors and take appropriate measures to maintain the stability and liquidity of financial markets. This requires informed decision-making and flexible policy tools by policymakers.
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