(Business Insider) There's no denying that the Federal Reserve has been at the forefront of investor attention in 2019.
In the middle of a steep market decline — and after raising interest rates three times in 2018 — the Fed flipped their monetary-policy path 180 degrees and cut rates three times in 2019. Tranquility followed and higher markets ensued.
But then something strange happened. In mid-September, a sudden jump in rates within an integral portion of the financial system caused a panic.
"We stopped quantitative tightening early in the year, and we went to quantitative easing — maybe," Jeffrey Gundlach, the billionaire CEO and chief investment officer of DoubleLine Capital, said on a recent webcast. "It depends how you want to frame what is going on with the Fed increasing its balance sheet — pumping more reserves — to try to deal with the out-of-control repo problem that started up September 17."
The "repo problem" cited by Gundlach refers to the sudden rate spike in the market for repurchase agreements — an integral part of the US financial system where parties come together to exchange securities (mostly US Treasuries) for cash.
In response to the turmoil, the Fed injected stimulus into money markets to pull rates back down.
However, what was perceived as a one-time hiccup in markets has turned out to be more of a perpetual issue — and the Fed is still pumping cash into the system today, months after the initial quandary.
Since the repo turmoil began, the Fed's balance sheet has increased by hundreds of billions.
"It's not unusual for it to spike at year-end," Gundlach said. "But it is unusual for it spike out of the blue in the middle of September."
To Gundlach, the rate action taking place in the repo market is alarming — and there must be an explanation for this sudden increase.
"They blamed it on tax payments having to be made, causing a shortage of short-term money and also that there was a mismatch between maturing bills and bills that had to be issued," he said. "But what's strange about those explanations is that those facts were known before September 17."
In other words, Gundlach isn't buying the Fed's reasoning behind the rate spike. Treasury bill issuance and maturity is widely known information on Wall Street. There's a calendar depicting this. There must be some other reason for this dislocation within the market.
"It says to me that there isn't sufficient liquidity in the system, and there isn't sufficient demand therefore to float overnight money 'repo' at anything close to the fed funds rate," he said. "It's sort of the market rejecting the interest rate levels that the Fed has set."
"I take that as a very bad sign," he said.
