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Thursday, December 17, 2015

Thursday -- Some Outright Speculation

S&P E-mini Futures:
Moderate follow through from yesterday's rally.

The party continues. Green throughout major Asian and European markets.

If it is indeed true, as Citi maintains, that in order to effect a 25bp rise in the Fed funds rate, the Fed needs to drain up to $1 trillion of liquidity using its Overnight Reverse Repurchase Agreement Facility, there could be some bumpy sledding soon (speculation below).

But the Fed's own RRP desk quoted a much higher number:

"...the Desk anticipates that around $2 trillion of Treasury securities will be available for ON RRP operations to fulfill the FOMC’s domestic policy directive."


Also note, the word "available" means "for sale."

Further note the emphasis added in the Fed's own RRP definition:

Overnight Reverse Repurchase Agreement Facility

When the Federal Reserve conducts an overnight RRP, it sells a security to an eligible counterparty and simultaneously agrees to buy the security back the next day. This transaction does not affect the size of the System Open Market Account (SOMA) portfolio, but there is a reduction in reserve balances on the liability side of the Federal Reserve's balance sheet and a corresponding increase in reverse repo obligations while the trade is outstanding.

That is how liquidity will be sucked out of the system.

Then get a load of Guggenheim's Scott Minerd referencing the very same thing yesterday pre-Fed.

"The Fed is in uncharted water here . . . The amount of reserves that will have to be taken out of  the banking system . . . We have never attempted anything like this in the history of monetary policy . . ."

He is rightly concerned.

As Zero Hedge rightly pointed out:

"Putting this liquidity drain in context, the entire QE2 injected "only" $600 billion in liquidity in the span of many months, suggesting that as of tomorrow, the Fed may drain as much as 166% of its entire second quantitative easing operation overnight."

Many people dislike ZH, but don't shoot the messenger. They might have undershot by a lot.

USD strength. Not what the Fed wants.

Still messy. Still trending toward yield inversion too. Not what the Fed wants.

WTI crude hanging tough, but hit a new low yesterday. Same with NG.

Gold, silver, and copper down, possibly confirming the abundance of veiled deflation references by Yellen & Co. yesterday.

S&P Outlook:
So, if bond dealer liquidity was in the dumps before the Fed raised a measly 25 bips, and if $1 trillion of liquidity (or possibly much more, as the Fed itself said) must be removed to effect it -- something that "has never been attempted in the history of monetary policy" -- here might be a scenario for some rough sledding leading to a premature Fed backtrack.

Pure speculation, of course. But something that could eventually lead to epic shorting opportunities sometime in 2016 and 2017.

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