When many people talk about the Fed raising interest rates, they are not very clear about the concept in their minds. We often imagine it is very simple. An interest rate increase means that the central bank issues a notice, and then the interest rates of all banks increase the next day. Is it that simple? Obviously not.
1. The logic behind the Fed’s interest rate hike
What exactly is the interest rate adjusted by the Fed's interest rate hike? It adjusts the overnight lending rate between banks, which is the so-called federal benchmark interest rate. Some basic knowledge is involved here, let's do the foreshadowing first. As we all know, when depositors deposit money in the bank, the bank will deposit reserves in the central bank according to relevant requirements, such as 10%, and the remaining 90% is used for lending. However, the operating conditions of many banks are different. For example, small banks have difficulty in lending due to fewer customers and more deposits; while some large banks and international banks have more customers and more investment opportunities. Not enough, which forms a supply and demand relationship between funds. Some banks have large deposits but few loan customers; some banks have small deposits but many loan customers. There will be a demand from both parties, which will form a fund lending between the banks of both parties, and finally an interest rate will be formed. This interest rate is actually what we call the benchmark interest rate. What the Fed wants to adjust is this interest rate.
So how did the Fed adjust? Of course, it is impossible to directly issue a document or issue an announcement saying that I am going to raise the interest rate, and you have to change the interest rate for me. This is not acceptable. According to the traditional practice, the Federal Reserve wants to move the interest rate among the banks. It does not affect directly, but indirectly. We regard these inter-bank funds as a fund pool. Now there is too much water in this pool, and the interest rate is relatively low. How can I increase the interest rate now? I actually have to pump out part of the water , Let this amount of funds become scarce, and the interest rate will be raised, so the traditional approach of the Federal Reserve is to throw US treasury bonds from the balance sheet and withdraw money during this process. This will make money in the middle of the market scarce, and interest rates will rise. If the rise is not enough, I can continue to sell, and then collect liquidity, and finally the interest rate has been raised to the range specified by it. For example, in December 2015, the Federal Reserve adjusted the interest rate from 0% to 0.25% to 0.25% to 0.5%. This is a range, as long as it is within this range, it meets the requirements of the Federal Reserve.
So when it comes to the return of funds, the Fed threw out the treasury bonds and then took back the money, so where did the inflowing dollars go? In fact, it can't go anywhere, and the dollars that flow in disappear on the spot. What's going on? Let’s make an analogy: the Federal Reserve has a large warehouse. Everyone in the society, after working for a day, delivers the results of his labor to the warehouse of the Federal Reserve. When the Federal Reserve receives the goods or fruits of labor, which are worth 1 dollar, they will Give him a receipt worth 1 dollar, which is the dollar. So when we talk about the US dollar or any banknotes, we must be clear in our minds that these banknotes or banknotes are not wealth in themselves, but wealth is the result of labor stored in warehouses. You get the dollar, the currency is just a receipt of wealth. Before 1971, that is, in the era of the gold standard, the wealth behind the dollar was not really piled up with a lot of labor fruits, but gold was used as the representative of all labor fruits, so the assets were gold, and the receipts were dollars; if according to the exchange rate at that time In conversion, behind 1 dollar, there is nearly 1 gram of gold as support, so it is called the gold standard. Why is the U.S. dollar called the U.S. dollar in history? It is because there is nearly 1 gram of gold behind 1 dollar as asset collateral. If you get this dollar, you can theoretically go to the central bank to claim this 1 gram of gold. This is the monetary system of the United States before 1971. Of course, after 1971, this system was overthrown. Americans don’t want gold anymore, they don’t play gold anymore, what are they playing for? The United States has replaced its assets from gold with U.S. Treasury bonds, so now this $1, the mortgage asset behind this receipt is a $1 Treasury bond, that is, a piece of paper as collateral, creating another piece of paper, which is now all The world currency system. Well, after we understand this truth, let us imagine that the Federal Reserve is going to raise interest rates now. It actually wants to sell treasury bonds, actually throw assets (mortgage assets) into the market, and then withdraw money. In the process, That is to say, there are fewer things in its warehouse, because it is thrown out, so what is the use of the returned currency, of course it is useless, what to do, burn it with a fire. Therefore, in the process of selling assets and withdrawing currency, it will definitely mean that the Fed's balance sheet will shrink, and it will lose weight. This is an inevitable means of traditional interest rate hikes.Throw assets away, shrink your balance sheet, and drive up interest rates.
2. How the Fed raises interest rates
But now the situation has changed a lot. We know that after the financial crisis in 2008, the Federal Reserve carried out three consecutive quantitative easing (QE). In the middle of these three rounds of QE, what measures did it adopt? In fact, it is like the banking system. This kind of fund pool injects a large amount of currency, how to complete this process? The principle is the same, that is, to print a lot of dollars (receipts), go to the market to collect U.S. treasury bonds, send the funds out, and get back the U.S. treasury bonds, so that his balance sheet will expand. Correspondingly, his receipts, liabilities It will also expand, and this process is the process of quantitative easing.During this process, a problem arose, that is, after the first few rounds, after the first two rounds of quantitative easing, the currency on the market was silted up. Because the Federal Reserve wants to press the interest rate to zero, it will inject a large amount of money, and the inter-bank lending market will basically stop, because every bank has money in hand, you have money and I have money, and we have a lot of money. The three rounds of quantitative easing have injected a total of more than 3 trillion US dollars (how do I know? I checked the information). Originally, the Federal Reserve meant that I gave you the money, and hoped that you banks would lend the money quickly to stimulate the real economy, speed up economic recovery, speed up everyone’s hiring, and increase employment, but the situation did not happen in this way. The main reason is that After the financial crisis, the economic recovery of the United States was very slow, including the economic recovery of the whole world. After these banks took so much money, they couldn’t find reliable loan customers, so they couldn’t release it. What should I do? After the release of the base currency of more than 3 trillion yuan, the banks cannot effectively lend money, so they (banks) can only pile up the money in their excess reserve account with the central bank (Fed). How much? The Federal Reserve injected 3 trillion US dollars, and as a result, the amount piled up in the excess reserve account reached 2.4 trillion, which shows why the economic recovery is not smooth. The key reason is that the money did not go out, and it was all piled up in the bank. This actually exists There is a law of diminishing marginal returns, that is, when the funds are injected in the first round in the early stage, the effect is very obvious. After the bank has more money, the interest rate will drop quickly, but the further the time goes, the more the interest rate will drop. Small. Before the financial crisis, the balance sheet of the Federal Reserve was only 700 to 800 billion U.S. dollars. After three rounds of quantitative easing, it has reached more than 4 trillion U.S. dollars. You want to raise interest rates now. According to the traditional method, you have to sell a lot of money and then increase the interest rate. However, because your scale is too large, you have a dilemma. Tossing such a large-scale national debt in the market is very difficult for the interest rate. The lifting effect is very small. Many people say that if China sells all the stored US treasury bonds, will the interest rate in the US treasury bond market skyrocket? In fact, no, China’s U.S. national debt is only more than 1 trillion, but the excess reserves of the U.S. banking system are as high as 2.4 trillion. Even if they are all thrown out, the impact on the U.S. interest rate market is very limited, which is estimated to be about 10 basis points or so. A little more will not be able to really affect the US financial market. Because the water in this pool is too deep.
If the traditional method of selling national debt, withdrawing currency, and pushing up interest rates does not work, what should we do? The Federal Reserve has thought of another method, which is called reverse repurchase . This is the way to drive up interest rates. Note that when we talk about reverse repurchase, you need to know that China and the United States are the opposite. China's reverse repurchase is to sell currency, and the United States' reverse repurchase is to withdraw currency. If we take a closer look at the interest rate when the Federal Reserve raised interest rates in December 2015, we will find that there have been several changes. The first event announced the target interest rate, raising the interest rate by 0.25%, which is the current 0.25%-0.5%; In addition, there is another interest, which is the interest of reverse repurchase, which is set at 0.25%. In addition, there is another interest, which is the interest on the excess reserve account, which used to be 0.25%. It is now 0.5%. There are more concepts involved here. First of all, the excess reserve account. In the past, the central bank stipulated that you must deposit your money with me. Not only must you deposit it with me, but I will not give you interest. After the outbreak of the financial crisis, the Fed printed a large amount of money, causing these banks to get the money and not lend it out, so they put the excess money in the excess reserve account (as mentioned before, it is 2.4 trillion US dollars) . In this way, there is no need for banks to lend to each other because everyone has money. In this way, there is no way for this money to generate more money, which will cause the bank to face great operating pressure, and it is difficult to make money. What should I do? Then everyone will go to the Federal Reserve to cry about being poor, and your old man can give us some interest, otherwise we can't do this business. Since then, the Fed has earned interest (0.25%) on the money held by banks in their excess reserve accounts. That is, if you deposit money in the Federal Reserve, the money can also earn interest income, which was not available before. It is precisely because the Federal Reserve gives the 0.25% interest on the money in the excess reserve account that the bank obtains an additional income.
Then why is the real interest rate formed in the market lower than 0.25%? For example, in some cases, it is between 0.05% and 0.13%. How is this market interest rate formed? This involves another issue, that is, there are two different types of participants in the U.S. interbank capital market. One is called the regular army, which is the U.S. commercial banks that are directly managed by the Federal Reserve , so they are called the regular army. There is also a category called miscellaneous forces, that is , these institutions or banks that are not under the management of the Federal Reserve . The problem now is that the regular army has such an excess reserve account with the Federal Reserve, but the mobsters do not have this account, so the 0.25% interest given by the Fed can be obtained by the regular army, but the mobsters cannot. However, there are also many institutions or banks with spare money in the hands of the motley crew. Since I can't get a fixed return of 0.25%, I can only make a little money in the market. For example earning 0.05%, 0.10% and so on. Therefore, after the financial crisis, these motley crews became the dominant force in determining interest rates among U.S. banks in this market. That is to say, the big banks all deposit to the Federal Reserve to eat a high-return interest rate, so it will not do transactions below 0.25%, but the mobsters still need to lend, and they are willing to accept lower interest rates, and in the process the bank There is also a big profit. why? It can save at high interest rates. Of course, this high interest rate is relative. For example, if your trading price is 0.10%, if I add a little more, I can attract your funds to me, and then I will take this money and deposit it in the Federal Reserve. Over there, I get 0.25% return, and here I give you 0.10% interest or a little higher, and all the difference in the middle belongs to me. This is called risk-free arbitrage, or the Fed's policy arbitrage for banks. Formally , because there are two types of people participating in this market, this will form a situation where the interest rate will be lower than 0.25%, but slightly higher than 0.
Okay, let’s go back to the previous topic again. It was said that the interest rates set by the Federal Reserve in December 2015 include the benchmark interest rate, the reverse repurchase rate, and the interest rate on excess reserves. That is to say, the Federal Reserve uses the reverse repurchase rate of 0.25% as the bottom and 0.5% of the bank’s excess reserves as the top, so that the future interest rate range will fluctuate within this range. We understand very well that banks can receive a fixed 0.5% interest as long as they deposit money in the Federal Reserve. What is the point of this? That is, why can 0.25% of the reverse repurchase form a bottom? If the Federal Reserve wants to set a floor for interest rates, the easiest way is to recruit a motley crew. You all come to my Fed to open an excess reserve account, and I will give you 0.25% directly, so that everyone will not go out in the trading market. The transaction was conducted at a price lower than 0.25%. The reason is very simple. The Federal Reserve is the most reliable counterparty. If I lend him money, there is no one more reliable than him, so why should I lend it to others, so Below 0.25%, it is impossible to have a market, which is the easiest way. But there is a problem with this method, which has legal obstacles, because the Federal Reserve Act stipulates that the Fed’s influence on the interest rate market can only be indirectly affected by buying and selling government bonds. It is not allowed to say that I directly open an excess reserve account for the mobsters. It is not allowed to pay him interest. The law does not give him this authorization, so the Federal Reserve must find a way to bypass this legal obstacle. What is the way? It is reverse repurchase.
The process of reverse repurchase is simple to understand, that is, the Federal Reserve actually withdraws currency from the hands of the mobsters, because the Fed is not allowed to directly get the money from the mobsters, so the treasury bonds are regarded as trading goods, that is, I give you the treasury bonds, and you give the currency to me . At this time, the currency will be withdrawn. But I promise that the next morning, I will give you the money, and you will give me the national debt. Plus I'm attaching 0.25% interest. Why do such a transaction? This transaction is actually in our understanding. Didn’t anything happen the next morning? You still pay others 0.25% interest. In fact, because this transaction can be rolled over, it can be done again the next day, and paid back on the third day. You can do it again, and you can do it again after the expiration, which is actually equivalent to returning the money to the Federal Reserve. This effect is actually equivalent to the Federal Reserve opening an excess reserve account for the mobsters, in which the Fed pays 0.25% interest to the mobsters. It is tantamount to incorporating the motley crew without violating the Federal Reserve Act. why? Because the repurchase does indeed involve the sale of national debt and the purchase of national debt, it is only one day, but it is not illegal for one day.
After this interest rate change, the excess reserve is 0.5%, and the reverse repurchase is 0.25%. Within this range, banks still have arbitrage opportunities. There is less interest for others, and there is still room for normal arbitrage in the end. What I just introduced are some specific details, logic and general operation methods behind the Fed's interest rate hike.
Some friends may feel that these things are so boring. What the Fed does has nothing to do with me. I only care about how to make money. Writing about these things is better than writing some technical articles. In fact, there are two purposes for saying this : 1. To popularize knowledge . The more people know about these details and the clearer they understand, the better they can understand the nature of finance and the nature of currency operation. 2. Only after understanding these details, can we make reasonable inferences instead of nonsense conspiracy theories, which can help you dissect the fundamentals and understand the trend of currencies. You know, money is earned by veterans in every industry. When you enter this market, you don’t even know the rules and gameplay formulated by the host. What do you use to play with others?
3. Some digressions
Now we know exactly how it works, which is to raise interest rates through reverse repurchase rather than shrinking the balance sheet. Why does the Federal Reserve do this, or what is the point of it doing so. As I just mentioned, after the three rounds of QE, Bank of America accumulated a large amount of funds (about 2.4 trillion), and then deposited these funds into the Fed's excess reserve account to eat interest. So whether the money is still in the account is worth scrutinizing. I think it may not be as simple as we understand, because it is impossible for these big banks in the United States to be willing to put this huge sum of money in the excess reserve account and just eat it. 0.25% interest, this interest is too meager, is there a better way to make money? Of course, if you can mobilize this money to play high-risk games, you can certainly earn more. For example, a simple way is to use the repurchase operation, that is, I transfer the funds in my excess reserves, and I can get back the national debt in the repurchase market, and lend this money, and these national debts, I can go to a foreign branch (such as a branch in London) through remortgage, then the branch in London can get these national debts, and I can continue to remortgage in London, one time, two times or three times, and I can transfer a lot Once, in this way, they can raise funds in London and engage in high-stakes games. You may be wondering why you want to move to London instead of other places? Because London's financial control is much looser than that of the United States. The reason why London has become the world's financial center again is because that place has very loose regulations. China does not allow such things as treasury bonds to be re-mortgaged, and the United States also has strict restrictions. The average number of collateral re-mortgages is at most 1.4 times. What about London? There is no limit at all, you can re-mortgage as many times as you want, so London encourages everyone to take risks, and the financial control is also very loose.
To digress a little bit, I just talked about the high-risk game after transferring funds to London, so what effect will such an operation have? From the accounting point of view, there is absolutely no loophole, because the repurchase is a round trip the next day, which does not need to be recorded on the balance sheet, so in theory, the 2.4 trillion excess reserves The money in the account has not been moved. In fact, it may have been transferred to London in large quantities through repurchases, and many high-risk transactions were made there (the demise of the London whale is related to this). If this is the case, then we will put a question mark on whether the entire excess reserve, including the funds inside it, will go away. It is very possible, of course, we do not know the exact number, there is no such a large amount of money in the excess reserve account, and the money has been dropped out long ago. If this is the case, it is impossible for the Fed to adopt the method of shrinking the balance sheet To raise interest rates, on the one hand, it has a practical operational difficulty. On the other hand, if you want to shrink the balance sheet, it means that a lot of money in the middle of the 2.4 trillion excess reserves will be recovered and returned! Once you collect it like this, the bank’s money is theoretically on the books, but in fact it has been transferred out a long time ago. If you try to collect it, then their problem will be exposed, and this exposure is likely to be a huge problem. , It will trigger a series of chain reactions, and even induce a financial crisis.
What kind of impact will the Fed's interest rate hike, especially the possibility of further interest rate hikes in the future, have on the world?
Benefits: The Fed’s interest rate hike shows that the U.S. economy is recovering well, so it dares to raise interest rates . This is an optimistic view, but in fact, we will find many problems if we only observe from the outside. For example, if the U.S. economy It’s really good (2/3 of its economy depends on consumption), so consumption must be very strong. Strong consumption in the United States means that China’s exports must be very prosperous. It’s very simple. Many things that Americans consume are exported from China. of. So China's exports will obviously be very hot, right, but the actual situation is of course not the case. On the other hand, if China's exports are booming, it will lead to a substantial increase in the volume of sea freight. Let's look at the current freight index (Baltic Sea Work Index), which can be said to have fallen to a horrible level. In addition, if China uses its power to produce consumer goods for the United States, the prices of bulk commodities and oil should rebound. From all aspects of our view, the trend is different from that of the US economic recovery. In other words, none of the indicators that should be brought out by the recovery of the US economy have appeared. Just by observing these external indicators, we can draw a very simple conclusion that the economic recovery of the United States is not as healthy as it is said, because none of the surrounding indicators is improving. So why would he do it? If you are interested, you can do your own research.
Cons: Lots of problems. Because if everyone expects that the United States will raise interest rates in the future, a lot of funds will flow out and return to the United States. The reason is very simple. Because in the previous rounds of quantitative calculations, the United States has reduced the interest rate to 0, and through the above-mentioned means of operation, a large amount of money has been injected. The money cannot stay in the US banking system, and there is still a lot Part of it has flowed to the whole world. After such words have flowed to the world, the dollar debts of various countries around the world have increased significantly, and at the same time, asset prices have been pushed up. Emerging market countries are now facing the most serious problems. The combined dollar liabilities of all emerging market countries have reached 5 trillion US dollars. Why do their debts expand so quickly? A few years ago, seeing the low interest rate of the U.S. dollar, I borrowed U.S. dollars from the international market. Whether it was a U.S. dollar loan or a U.S. dollar bond, the funds I raised were lower than the cost of domestic financing. Why didn’t I borrow? So desperately borrowing US dollar debt, so a huge debt piled up, the whole world added up to 9.2 trillion, and emerging market countries alone accounted for 5 trillion, such a huge debt piled up. Well, the Fed is going to raise interest rates now, and this debt has risen, but the debt is rigid, and once your funds have to flow back, how do you repay these huge debts? And it's all priced in U.S. dollars. As soon as the funds flow out, you will find that the liquidity of the US dollar is scarce in the international market, and the US dollar cannot be found. In this case, the US dollar will appreciate, and the scarcer it is, the more it will appreciate. Then these countries will face a serious panic at this time. Many companies and many individuals have borrowed US dollar debts, as if desperately accelerating repayment, which will cause or induce large-scale capital outflows in these countries, which cannot be stopped. . This will cause the local currency to depreciate and the dollar to appreciate. The more the local currency depreciates, the more panicked these domestic debtors in US dollars will be. They will accelerate the sale of assets, accelerate the exchange of dollars, and accelerate escape. This will lead to a vicious circle. That is, the more assets are dumped, the lower asset prices will be. At the same time, the depreciation of the local currency, capital outflow, and a series of follow-up reactions will cause serious hidden dangers to the country's economic and financial system. In particular, many countries used to be pegged to the U.S. dollar. Under the influence of U.S. interest rate hikes, capital outflows were too strong, and foreign exchange reserves were insufficient, so they were forced to announce decoupling. This decoupling will immediately lead to serious turmoil in the entire exchange rate system.
Fundamental analysis is interesting here. Many interesting questions can be seen.
Add
