2008 and 2019 - Stock Market Crash: Similar Signs Now! S&P 5002008 and 2019 - Stock Market Crash: Similar Signs Now! -Reverse Repo and S&P 500: Inverse Correlation is Screaming.
Here are 5 Highlights:
1:: Quantitative tightening has been underway since June 2022, and the Fed will have to make a Big Move- iin September 2024:
2:: The overnight reverse repo facility is now getting down to low levels, raising questions about whether another breakdown in financial market liquidity and stress in short-term funding markets could occur.:
3:: On January -2022, the chart shows that the REVERSE REPO started to increase and at the same time S&P 500 started to drop, showing an almost perfect inverse correlation.:
4:: What Happened in the 2008 G-F-C - Quantitative tightening, and in September of that Year?
5:: What was the: dash for cash, and what happened in the September 2019 Repo Crisis?
Quantitative tightening (QT) has been underway since June 2022, with the Fed shrinking its balance sheet in order to bring reserves and liquidity in the financial system back down to more normal levels.
The CME's FedWatch Tool forecasts that the federal funds rate will most likely end 2024 at 4.25% to 4.5%. If so, that's a full percentage point lower than current rates. However, there's substantial uncertainty around that estimate and a higher, or lower, degree of policy accommodation is possible;
The overnight reverse repo facility is now getting down to low levels, raising questions about whether another breakdown in financial market liquidity and stress in short-term funding markets could occur.
I believe that an unexpected rate spike, similar to September of 2019 is unlikely, considering the current liquidity conditions, but the chart I have created triggered a Warning Sign.
As you can see, usually there is a clear Inverse Correlation with REVERSE REPO, and the US STOCK MARKET.
On January -2022, the chart shows that the REVERSE REPO started to increase and at the same time SPX started to drop, showing an almost perfect inverse correlation.
On May - 2023, the chart shows SPX, at the start of a Bull Market as REVERSE REPO is on a Downtrend.
What I have noticed, is that when they are running beside each other, at some point they start to go in the opposite direction, and when they are far apart from each other, at some point they start to converge, going in the opposite direction, crossing at some times.
Since they are really far from each other, the next inverse correlation move could be huge.
So, the question is, the pattern will follow, and if it does how much will the stock market Crash when Reverse Repo starts to spike UP?
For now, I do not see a breakout of the Downtrend for Reverso Repo, but we need to keep very close attention when that happens, to review our stop loss.
Since I have never seen this analysis between the Reverse Repo and the US Stock Market, I had to publish it as soon as possible to warn as many people as I could, of what could happen, anytime from now.
If you know anybody who has made this analysis, let me know in the comments below.
What is the Reverse Repurchase Agreement?
A reverse repurchase agreement (RRP), or reverse repo, involves the sale of securities with an agreement to repurchase them later at a higher price on a specified future date. It represents the seller's perspective in a repurchase agreement (RP), or repo.
The difference between the initial sale price and the repurchase price, along with the timing of the transaction—often overnight—represents the interest paid by the seller to the buyer.
In the U.S. repo market, more than $3 trillion in short-term funding is provided daily, with most transactions being overnight and collateralized by Treasuries. Repos are commonly used for short-term borrowing and lending.
How Does a Reverse Repo Work?
In a reverse repo, a party in need of cash reserves temporarily sells a business asset, equipment, or shares in another company, with an agreement to repurchase them later at a premium. The buyer of the assets in a repo agreement earns interest for providing liquidity to the seller, while the underlying collateral helps mitigate the risk of the transaction.
Example of Reverse Repurchase Agreements
Consider Bank ABC, which has excess cash reserves and wants to earn a return on them. Meanwhile, Bank XYZ faces a reserve shortfall and needs a temporary cash infusion.
Bank XYZ may enter a reverse repo agreement with Bank ABC, selling securities to Bank ABC to hold overnight and agreeing to buy them back at a slightly higher price the next day. From Bank ABC’s perspective, this transaction is a repurchase agreement.
How Does the Federal Reserve Use Reverse Repos?
When the Federal Reserve engages in a reverse repo, it sells securities with an agreement to repurchase them later. In doing so, the Fed borrows money from the market, which can help absorb excess liquidity in the financial system.
The Bottom Line
A reverse repurchase agreement (RRP), or reverse repo, is the sale of assets with an agreement to repurchase them later at a higher price. Essentially, it functions as a short-term loan with the sold assets serving as collateral.
What Happened to the Repo Market during QE of 2008, and What happened in September of that Year?
During the 2008 financial crisis, the repo market faced severe liquidity stress as financial institutions struggled to obtain short-term funding. The repo market, where institutions borrow cash by selling securities with an agreement to repurchase them later, is a crucial source of liquidity for banks and financial firms.
However, as the crisis unfolded, the value of the collateral—primarily mortgage-backed securities and other complex financial instruments—plummeted. This led to a sharp increase in haircuts (the discount applied to the collateral), causing lenders to demand more collateral for the same amount of cash.
The resulting lack of confidence in counterparties and declining asset values led to a run on the repo market, where borrowers were unable to roll over their repos or obtain new funding. This liquidity crunch intensified the financial crisis, leading to the collapse of major institutions like Lehman Brothers and prompting the Federal Reserve and other central banks to intervene by injecting liquidity and expanding their roles in the repo market to stabilize the financial system.
During the 2008 financial crisis, U.S. bank reserves became scarce in the period leading up to the implementation of Quantitative Easing (QE) by the Federal Reserve.
So, what happened in September 2008?
This scarcity of reserves was most pronounced in the fall of 2008, especially following the collapse of Lehman Brothers in September.
At that time, the interbank lending market froze as banks became increasingly risk-averse and reluctant to lend to one another due to fears of counterparty default.
This resulted in a severe liquidity crisis, making reserves—cash that banks hold at the Federal Reserve—scarce. Banks hoarded reserves to ensure they could meet their own funding needs, leading to a sharp increase in the cost of borrowing reserves, as reflected in the spike of the federal funds rate above the Fed's target.
To address this, the Federal Reserve initiated a series of emergency measures:
Liquidity Facilities: The Fed introduced several facilities, such as the Term Auction Facility (TAF) and Primary Dealer Credit Facility (PDCF), to provide liquidity to banks and primary dealers.
Quantitative Easing (QE): Beginning in late 2008, the Fed started its first round of QE, which involved purchasing large quantities of longer-term securities, including U.S. Treasuries and mortgage-backed securities (MBS). These purchases injected substantial reserves into the banking system, alleviating the scarcity of reserves and lowering borrowing costs across the economy.
By increasing the supply of reserves through these measures, the Fed aimed to stabilize the financial system, restore normal functioning to credit markets, and support economic recovery.
With the advent of quantitative easing in 2008, the U.S. Federal Reserve (Fed) moved from a scarce to an ample reserves regime. The Fed used to control rates by managing the supply of bank reserves so that interest rates would clear at target.
But now banks frequently hold substantial reserves. These reserves are now managed and incentivized by the Fed, which pays interest rates on reserve balances (IORB).
Non-banks, such as money market funds, can also park money at the Fed’s Overnight Reverse Repo Facility.
These two mechanisms act as a floor system, allowing the Fed to control short-term interest rates. For example, if interbank rates fell below IORB, a bank could make more money using the Fed facility and would do so.
What was the: dash for cash, and what happened in the September 2019 Repo Crisis?
The recent dash for cash highlighted the importance of understanding liquidity stress dynamics in key funding markets.
The sharp spikes in repo rates in March 2020 were clear signs of severe liquidity stress. We previously observed similar stresses in money markets when reserves became scarce in September 2019.
The Fed's quantitative tightening (QT) began in the fall of 2017, and by mid-September 2019, $700 billion in reserves had been drained from the financial system.
What Happened in September 2019?
On September 16, 2019, $70 billion was withdrawn from banks and money market funds to meet quarterly tax payments. Simultaneously, $50 billion in long-term Treasuries settled, which were purchased by dealers, further straining their reserve positions.
At that time, hedge funds significantly ramped up their borrowing, and repo spreads widened, particularly in the bilateral segment of the market, where banks and gilt dealers were lending at much higher rates compared to borrowing from non-banks.
Will the Fed respond the same way this time? Could the same liquidity-type crises happen again?
First, it's important to recognize that in 2019 and 2020, the Fed used repos reactively as a firefighting tool to address liquidity crises. Learning from these market disruptions, the Fed established a new standing repo facility (SRF) to proactively provide liquidity whenever needed. This facility has a capacity of $500 billion, which is expected to be sufficient to handle liquidity demands during future periods of stress.
Additionally, the Fed introduced another repo facility called the Foreign and International Monetary Authorities (FIMA) Repo Facility, allowing foreign central banks to access dollar liquidity. Generally, the Fed aims to avoid repeating past mistakes.
Reflecting this, the Fed recently announced a reduction in the pace of quantitative tightening (QT) for its Treasury securities from $60 billion to $25 billion per month, partly to lower the risk of another liquidity crunch.
Looking ahead, a new ruling by the U.S. Securities and Exchange Commission (SEC) from December 2023 mandates a shift to central clearing of repos by June 30, 2026.
What could still go wrong?
The Treasury market seems more fragile now than it was before the Global Financial Crisis (GFC). Algorithms account for 60%-80% of trading depth at any given time, but they tend to shut down during periods of high volatility, such as market scares. This can exacerbate fragility during risk-off events, especially with dealers constrained by post-GFC capital rules.
There is a circular relationship between the Fed and the markets. The Fed cannot precisely determine in advance when reserves will shift from being ample to scarce; instead, it relies on market signals and pressures to gauge when a tipping point might be near.
Speaking at the U.S. Monetary Policy Forum in New York on March 1, 2024, Fed Governor Christopher Waller noted that increased use of the Standing Repo Facility (SRF) could indicate that reserves are nearing an ample level. However, this still leaves directional illiquidity risks in the market, even if those risks are somewhat mitigated by the new backstop measures.
The bottom line
What is beginning to happen is that there are new protocols in Treasury markets for trading all-to-all participants. These algorithms will reduce capital, and hedge funds will begin to step in. As these protocols get built out, more non-traditional price makers and market participants will be able to help support unexpected stress in the Treasury market.
The institutional features are in place and have changed the market structure to reduce the risk of a repeat of 2008 and 2019, but everything has a limit at some point, and something is unbreakable until it breaks.
This lesson we all have learned from Titanic is: never doubt about a natural force's power. I believe, that even the abstract reality of money and markets follow the same principle, and when this natural force decides to act, no one can stop it, otherwise they could've prevented what happened in 2008 and 2019.
Technical analysis is not 100% perfect, as any other financial instrument that tries to predict the market, but the signals I have captured from the Inverse Correlation of the US Reverse Repo Market and the US Stock Market, are Very Strong.
If the US Reverse Repo market starts a strong Uptrend, it could trigger the Stock Market Crash.
Since, we are expecting big moves from the Fed in September, which is a regular period of withdrawal from banks and money market funds to meet quarterly tax payments, volatility is on the way; maybe the Fed will be able to hold liquidity steady, but only time will tell.
From my experience, this is the best time to review all investment strategies cutting risks as much as possible. Let's hope for the best while preparing for the worst.
- Good Luck and Good Profit My Friends:
Disclaimer:
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