What's Up Doc?

By: Rob Kirby | Wed, Nov 9, 2005
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We all know the Fed is in a rate tightening mode - right? In fact, this past week the Fed raised their benchmark rate [the overnight inter-bank lending rate or Fed Funds Rate] by twenty five basis points [.25] for the twelfth successive time to 4.00%. For those of you who might not have been keeping score - that would be an aggregate of 300 basis points of "tightening" over the past couple of years - from the 'easy money days' when overnight money could be had for a paltry rate of 1.00%.

The official line being fed to us by the Fed [note the pun - just for fun], according to CNN that is:

Fed's Inflation Vigilance Persists
Policymakers continue with tough talk on price pressures; speeches suggest more rate hikes ahead.
October 21, 2005: 7:13 AM EDT

So, knowing all this - that the Fed is 'on the job' - so to speak - I guess we can all sleep well knowing that any inflation fires that might stir up will be quickly and efficiently doused by the custodians of sound money at the Federal Reserve - we can all see they are [and have been since June 04] raising interest rates - right?

 

Whoa Nelly...Not So Quick

Looking under a few rocks, it's amazing what one can see - or might find! This picture would seem to paint a different picture:


Chart compliments of Jesse

The old saying that a picture is worth a thousand words certainly applies to the piece of work above [special thanks to Jesse]! If we look at the dates along the bottom of this chart - it is clear for anyone to see that the yield on the 10-year benchmark government bond has actually decreased since the Fed began raising interest rates in June of '04 - the oft cited Greenspan Conundrum.

Not only have 'long term rates' actually declined, it is also clear to see [through the green bars protruding from the bottom] that Securities Lending is and has been increasing at ever healthy [stealthy perhaps?] rates. So what is this Securities Lending all about anyway?

Different Hat, Same Rabbit

In the passage cited above, according to [in case you missed it] Goldman Sachs:

"Estimates of the size of the equity securities lending markets are in excess of US$700 billion, with significant participation from mutual funds, pension plans, endowments and insurance companies. "

and

"Our programs are designed to be transparent to your daily trading and investing activities, and will therefore not impact your ability to trade your portfolio."

So don't kid yourself. Securities Lending is BIG BUSINESS. But the part about securities being transparent - that bothers me - because according to Capco,

"Securities lending and borrowing is a curtain raiser to derivatives trading, where it can facilitate smooth operations."

And On With The Show - This Is It!

With the curtain raised, or perhaps a little look backstage - so to speak, we might assume that Securities Lending and derivatives go hand-in-hand with each other. We all know that mountains of material have been written on derivatives and their inherent lack of transparency because they are "off balance sheet items" and only [if at all] get nominal mention in the notes to financial statements. We also know that current Fed Chairman Alan Greenspan is a huge proponent of derivatives and their remaining in the realm of "unregulated" owing to the "flexibility" they give the financial system - which coincidentally implies continued lack of transparency. I hope you all noticed the double speak regarding "derivatives" and "transparency."

Now Securities Lending implies that someone 'borrows' and another entity 'lends.' If we take a look see at the latest [past 2 weeks] of Fed Reserve Open Market Operations - they've been doing a fair amount of borrowing lately:


Chart courtesy of: www.omo.co.nz

It is clear to see that the Fed has been injecting another round of virtually unprecedented "liquidity" into the financial market place. Repos or short term 'borrowing' of securities by the Fed temporarily injects cash into the coffers of financial houses who 'lend' the securities. This cash injected into the financial system then "looks" for a home - be it the stock market or bond market. This is perhaps better illustrated through this chart which provides a little more context to the latest Fed add which categorically serves as a flashing neon light signaling system stress in the financial system - the root cause of the malady being somewhat moot:


Chart courtesy of: www.omo.co.nz

In summary, what this all shows is: While the Fed claims to be vigilant on containing inflation - their actions speak louder than their words and their 'flexible' actions [copious amounts of liquidity] are the fuel that's fanning the flames of inflation.


 

Rob Kirby

Author: Rob Kirby

Rob Kirby
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