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GDP growth in the third quarter of 2019 stands at 2.1%, according to current estimates. The economy has been humming along at 2% since the first quarter of 2016. Unemployment, too, points to a strong economy. Currently, unemployment stands at just 3.7%, its lowest reading since 1969. The DOW Jones average is at over 29,000, the highest it has ever been. By all accounts, the economy is in better shape than it has been in for over a decade.
Despite this, there is still good reason to be uncertain of the future. This uncertainty comes from a part of the economy the average citizen might know even existed. Enter the repo market.
Before I get into why you should be afraid, I would like to explain to those of you who actually have lives what the repo market is. The repurchase market is a financial market primarily used by large banks and the Federal Reserve.
In this market, banks loan out low-interest bonds, such as Treasury bonds and government securities. These loans typically have interest rates that hover between 1.5-2% and are usually paid back within a day or a week. While this market goes unnoticed, it deals with over a trillion dollars a day in sales. It is, essentially, a liquidity market for banks. Banks often need more liquidity to cover their daily business than they have on hand. So to attain this liquidity, they go to the repo market.
Now that you have as much understanding as I do on how these markets work, it’s time to jump into why they are irrevocably broken. On September 17, the overnight repo market interest rates, which usually stay below 2%, inexplicably jumped to over 10%.
The sudden volatility spooked the Federal Reserve, which, over the next four days, pumped 75 billion dollars into the market to cool interest rates. Since then, the Fed has invested almost half a trillion dollars into the market.
What caused the sudden need for free cash? No one is certain. One suggestion, made by Kiril Nikolaev over at CCN, is that JPMorgan drove rates up by refusing to lend on the market. They did this so to force the Fed into flooding free money into the system. This would, in the long run, lead to a rise in JPMorgan stock prices. If this is true, it is certainly troubling that a company like JPMorgan could so easily manipulate the market.
However, it is more worrisome that the market is over-leveraged to the point that such an event could become possible. And, the Fed’s continued effort to calm the market is even more troubling. The last time the Fed got this involved in the market, it was in the midst of the 2008 crash. If the market cannot sustain itself in the middle of this “booming” economy, then there may be larger troubles in the financial markets than it would seem on the surface.
I may be overreacting to one bad event. Maybe the economy will be fine into the next decade. However, the economy is overdue for a correction, and it may very well come from this under-noticed, underappreciated market.
Do you have a response to this article? Would you like to offer your own take on this topic? Feel free to submit your own article or offer a comment below.
Scott Howard is a constitutionally-minded conservative freelance writer with a focus on fiscal matters and foreign policy. He has been an active contributor to The Liberty Hawk. You can follow him on Twitter: @thenextTedCruz
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