Posted 6th September 2022

The Yield Curve Signals More QE Is Coming

precious metals feature imagery

In spite of the common narrative that the Fed’s monetary policy is “tight” or “hawkish,” it has not yet removed any liquidity from the banking system. 

The Fed’s balance sheet has been reduced to an immaterial amount since June when Quantitative Tightening was set to commence. 

Meanwhile, the U.S. Treasury Bond Yield Curve now sports a 40 basis point inversion between the 2-year and 10-year Treasuries. The last two times the 2/10 inverted by this much occurred in March 2000 and the spring of 2007 and the Fed followed suit by cutting the Fed funds rate and injecting liquidity into the banking system.

Operation: Money Printing

The point here is that, in addition to signalling that the economy is (globally) sinking quickly into a deep recession, the extreme yield curve inversion is telling the market that the banking system is starved for liquidity – liquidity that the Fed and other Central Banks will soon have to provide by resuming a large scale money printing operation. 

Yes, there may be $2 trillion sitting in “suspended animation” in the Fed’s overnight reverse report facility. However, this is the spot most devoid of risk to park that liquidity and earn over 2% annualized on it.

The big “too big to fail” banks ultimately need that capital to offset their increasingly illiquid, off-balance-sheet OTC derivatives and their exposure to an escalating amount of “on balance sheet” subprime and distressed loans (mortgages, auto loans, business loans). 

Liquidity Needed to Stave off Implosion

In other words, the banks and money market funds parking cash at the Fed are doing so because they do not like the risk involved with lending money even on a short-term basis to entities that need the cash. As such, at some point, the Central Banks will have to create new liquidity in order to keep the financial system from imploding.

The market’s realization that the Central Banks – especially the Fed – are faced with the choice of “print or collapse” is the reason the precious metals sector is bottoming and is headed higher.

On days when “risk-on” capital floods into the most speculative stocks, capital is also flowing briskly into silver and mining stocks. In those days, the broad mining stock indices outperform the major stock indices like the Dow, S&P 500 and Nasdaq. 

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The views expressed in this article are those held by Dave Kranzler and not Kinesis.