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What is the Federal Reserve?

The Federal Reserve is the central bank of the United States and is considered to be the most powerful financial institution in the world.
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This article was originally published by Value The Markets

The Federal Reserve, also often known as the Fed, is the central bank of the United States and is considered to be the most powerful financial institution in the world. The Federal Reserve was founded in 1913 to provide the US with a safe, flexible and stable monetary and financial system.

The purpose of a central bank is to create a financial institution that has privileged control over the production and distribution of money and credit for the nation or group of nations that it serves. Other examples of central banks include the Bank of England, the European Central Bank and the Swiss National Bank.

How the Federal Reserve works

The Federal Reserve is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the US. They are:

  • Federal Reserve Bank of Boston
  • Federal Reserve Bank of New York
  • Federal Reserve Bank of Philadelphia
  • Federal Reserve Bank of Cleveland
  • Federal Reserve Bank of Richmond
  • Federal Reserve Bank of Atlanta
  • Federal Reserve Bank of Chicago
  • Federal Reserve Bank of St. Louis
  • Federal Reserve Bank of Minneapolis
  • Federal Reserve Bank of Kansas City
  • Federal Reserve Bank of Dallas
  • Federal Reserve Bank of San Francisco

There are two main objectives of the Federal Reserve, to foster economic conditions that achieve stable prices and maximum sustainable employment. The duties of the Federal Reserve can be further categorized into four key areas:

The Federal Reserve was founded in response to the financial panic of 1907. Prior to its inception, the US was the only major financial power without a central bank.

  1. Conducting national monetary policy by influencing monetary and credit conditions in the US economy to ensure maximum employment, stable prices, and moderate long-term interest rates.
  2. Supervising and regulating banking institutions to ensure the safety of the US banking and financial system and to protect consumers’ credit rights.
  3. Maintaining financial system stability and containing systemic risk.
  4. Providing financial services, including a pivotal role in operating the national payments system, depository institutions, the US government, and foreign official institutions.

The organizational structure of the Federal Reserve consists of seven members on the Board of Governors. Each is nominated by the president and approved by the US Senate. A governor can only serve a maximum of 14 years on the board and their appointment is staggered by two years.

It is also dictated by law that appointments of governors must represent broad sectors of the US economy. In addition, each of the 12 Federal Reserve banks has its own president.

The Board of Governors are responsible for setting reserve requirements, the amount of money banks are required to hold to meet the demands of sudden withdrawals. They also set the discount rate, which is the interest rate the Federal Reserve charges on loans made to financial institutions and other commercial banks.

Central banks across the world play an important role in quantitative easing to expand private credit, lower interest rates and drive investment and commercial activity through FOMC decision making.

Quantitative easing is used to stimulate economies during periods of uncertainty such as recessions when credit is thin on the ground. An example of when quantitative easing was used was during and following the 2008 financial crisis.

Advantages of the Federal Reserve

The advantages of the Federal Reserve include:

Provides stability

During times of recession and periods of uncertainty, the Federal Reserve can help remove panic and provide help to financial institutions and their depositors in times of severe economic crisis.

Good risk containment system

The Federal Reserve regularly runs checks on the nation’s banks and financial institutions. It runs stress tests and reviews financial statements to make sure that the public is dealing with institutions that are in good financial standing, and are not overloaded with risk.

Disadvantages of the Federal Reserve

The disadvantages of the Federal Reserve include:

Not completely transparent

Many believe that private interest and lobby groups have significant influence over the Federal Reserve, allowing individuals to benefit rather than actions that benefit the whole society.

The post What is the Federal Reserve? appeared first on Value the Markets.

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Will Slowing Economic Growth Delay Fed’s Tapering?

Federal Reserve officials have recently been talking up the case for starting the process of tapering the central bank’s asset purchases. This baby step…

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Federal Reserve officials have recently been talking up the case for starting the process of tapering the central bank’s asset purchases. This baby step towards a more hawkish policy stance could begin as early as next month.

“While there is still room to improve on the employment leg of our mandate, I believe we have made enough progress such that tapering of our asset purchases should commence following our next FOMC meeting [Nov. 2-3],” Fed Governor Christopher Waller said earlier this week.

The reasoning is increasingly due to rising inflation pressures, even if Fed officials are downplaying that factor. But there’s an offsetting feature lurking: slower growth.

As reported by, there are signs that the economic rebound’s deceleration is picking up speed. Notably, the Atlanta Fed’s revised nowcast for the next week’s third-quarter GDP report has fallen sharply to a stall-speed 0.5% increase. Other estimates of Q3 growth are higher, but overall there’s a greater consensus among economic analysts and models that forward momentum for US economic activity is facing stronger headwinds. A key reason: shortages of goods and workers.

US economic activity is at risk of coming to a “screeching halt,” the owner of home-building firm in Florida told Congress this week. “Trying to schedule material deliveries has become almost impossible.”

The Fed is well aware of the shortages and, in fact, is talking about it. Mention of the word “shortage” in the central bank’s Beige Book, a regularly published summary of economic conditions, has surged recently, The Economist reports.

Although recession risk is still low, based on data published to date, economic activity looks set to slow for the near term, which could create new doubts about the wisdom of launching a hawkish shift in monetary policy.

To be sure, the market continues to price in low expectations for a rate hike through the first quarter of 2022, based on Fed funds futures. But a formal announcement of tapering next month would send a clear signal that central bank is officially moving in that direction.

The surge in inflation is surely putting pressure on the Fed to start moving away from its pandemic-driven stimulus posture. Consumer price inflation is now running far above the Fed’s 2% target. The central bank’s official line is that higher pricing pressure is still transitory, but there’s stronger evidence that the process of peaking inflation could last longer than previously expected, raising the thorny question: How long is too long?

Richmond Federal Reserve President Thomas Barkin admitted as much last Friday, telling CNBC: “I do think there’s risk on the inflation side, and I’m watching that very carefully.”

It’s unclear if higher inflation will convince the Fed to start tapering next month or delay the decision due to signs of softer economic growth. But in a sign of the times, Fed Governor Waller opened the door to that possibility in comments earlier this week: “Of course, if economic conditions and the outlook were to deteriorate significantly, we could slow or pause this tapering.”

Meanwhile, there’s still widespread agreement at the Fed that inflation is transitory, which gives the central bank cover for deciding to delay any tapering decision without invoking growth concerns. But as uncertainty rises on the inflation and growth aspects of the outlook, the risk of a policy mistake is rising.

If inflation stays hot and the economy continues to cool, an ill-timed policy decision is more likely than not. The question is: Where is the greater risk: letting inflation run hot without trying to contain it, or prematurely squeezing policy just as the economy is moving into what could be an extended soft patch — or recession, according to some economists.

Making monetary policy decisions in real time is always challenging. That’s the nature of the beast in central banking, for some obvious reasons: relying on lagging economic data with effects that take months, or even years, to show up in the economy. The key difference this time: the challenge is higher than usual as economists struggle to sort out where the real risks lie.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report

Author: James Picerno

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Is A Volatility Storm Coming?

Is A Volatility Storm Coming?

Authored by Patrick Hill via,

“Volatility often refers to the amount of uncertainty…

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Is A Volatility Storm Coming?

Authored by Patrick Hill via,

Volatility often refers to the amount of uncertainty or risk related to the size of changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction.”    – Investopedia

Federal Reserve Bond Tapering & Interest Rate Hikes Reduce Liquidity

Federal Reserve liquidity injections have bailed out the economy and equity markets for the last 18 months. And as a result, the bailout created a relatively low volatility environment for equity and bond markets.  Will the announced withdrawal of Fed injections of $120B per month set up the monetary system for higher volatility?  We see major economic forces combining in the intermediate future to create a possible ‘volatility storm’ driving valuations down. These economic forces include:

  • Fed tapering

  • Interest rate hikes

  • Inflation

  • Labor wage increases.

One of these macro factors is a challenge for monetary policymakers to mitigate damage to the financial system.  But, a combination of these factors already building may overwhelm the monetary system. Further, markets are at historic high valuations today. But, market weaknesses and structure, along with valuations may create optimal conditions for a volatility storm.

Taper Is Coming

In September, the minutes of the September Federal Open Market Committee meeting noted that most participants agreed that tapering of treasury and mortgage bond purchases should begin in December, but analysts expect a formal announcement at the November Fed meeting.  Accordingly, here is a forecast of how the projected tapering may occur into mid – June 2022.

Sources: Zero Hedge, Real Investment Advice – 10/15/21

The financial markets enjoyed about $2.16T in liquidity injections resulting in a low volatility monetary environment for the S&P 500 to bull market from a March 2020 low of 2191 to 4471. The impact of tapering is both real and psychological.  However, some analysts argue that the real reduction in bond purchases will have a minimal effect on bond markets.  Others note that while the actual withdrawal of treasury bond purchases in the $21.9T treasury market is small, the psychological aspects of tapering are significant.  Investors will feel the Federal Reserve is not ‘covering their downside risk’ anymore.

Some economists see an increase in volatility due to the end of bond purchases and increasing interest rates.  On Fox News, October 17th, Mohammed El-Erian, Chief Economic Advisor at Allianz SE, said he sees increased volatility in the future.

“I worry…that this wonderful world we’ve been living in of low volatility, everything going up, may come to a stop with higher volatility. If I were an investor, I would recognize that I’m riding a huge liquidity wave thanks to the Fed, but I would remember that waves tend to break at some point, so I would be very attentive.”

Inflation Surges to Decade Highs

The Consumer Price Index, CPI has moved above 5% on a year-over-year basis and it continues to rise.  Housing rent prices are up by 17.9%, according to the Case – Shiller housing September index.  Rent increases lead owner equivalent rent housing costs by five months based on a model by Macrobond and Nordea. This means that the 14% jump in existing home prices YoY is likely to extend into next year.   Below is a chart of the CPI since 2017 and major components such as housing and gasoline.

Sources: Bloomberg, Bureau of Labor Statistics – 10/13/21

The record prices of key commodities continue to drive the price of manufactured goods higher. Oil prices settled at $85 per barrel, a three-year high on October 15th.  Aluminum prices have increased by 40% in the last year.  The metal price hit a 13 year high on the London Metal Exchange on October 15th as well.  Copper prices surged by12% in the last week to the highest price since May 12th with a 74 year low in inventories.  Demand for primary metals has soared due to power generation demand and the shift to green power infrastructure systems. If passed, the $1T Bipartisan Infrastructure Bill agreed upon in Congress will likely keep commodities prices high for a couple of years.

China Boosting Demand

Plus, China continues to make considerable investments in manufacturing and power generation projects keeping global demand high for commodities.  Container shipping of commodities adds to their price.  Container shipping rates from Shanghai to Los Angeles have increased by ten times in the last year. Computer chip shortages continue with the highest delays on record in chip shipments for September and auto manufacturers have reduced production on some models by 10 – 20% reducing car inventories at dealers and supporting high new and used car prices.  Mitigating the surge in inflation would be declining consumer sentiment and buying, plus a possible slowdown in the global economy.  Yet, wages may continue to climb, causing businesses to respond with price increases.

Increased Wages Drive Demand Inflation

Increases in wages will possibly sustain demand.   Weekly earnings have soared to almost 10%.  This chart shows weekly earnings back to 1983, the last time earnings increased at this high level.

Source: Bloomberg – 10/12/21

Worker earnings increases continue to be driven by a labor shortage. There are 4.3M jobs left to fill since the labor force participation rate high of February 2020. Critical factors in many jobs not being filled include: 3.6M retirees not returning to the labor force, lower-wage hospitality workers into higher-paying warehouse and delivery jobs, and 2.5M workers staying at home to care for Covid-19 relatives.  The Wall Street Journal reports on October 14th the labor participation rate is at 61.6% versus 63.3% in February 2020. As a result, the labor force participation rate continues to be below pre-pandemic levels. 

Sources: Labor Department, The Wall Street Journal – 10/14/21

Labor Shortages Aren’t Helping

The National Federation of Independent Businesses recently reported that their Hard Jobs to Fill indicator shows that wages are likely to continue to soar. The following chart shows how the labor shortage is fueling a rise in wages.

Sources: NFIB, The Daily Shot 10/12/21

In many industries, the labor shortage is forcing employers to hire key employees away from competitors.  Accordingly, employers report in tight markets such as software programming offering 20% hire-on bonuses.   The restaurant industry’s average wage now stands above $15 per hour to attract workers in this 400% yearly worker churn sector.  Further, recruiters report that some workers seeing a tight labor market are evaluating work-life balance choices.  Also, drop-out workers in some cases are taking vacations, pursuing hobbies, or just taking a break.  Remote work-from-home options will continue to create tighter labor conditions for the foreseeable future.  A September Wall Street Journal survey of 52 economists showed that 42% expect the economy to not recover to pre-pandemic workforce levels for years to come.

Next, let’s look at how weaknesses in the market can provide clues on a gathering volatility storm.

Monthly, Weekly Time Frames Show Bearish Market Direction

Brett Freeze, principal at Global Technical Analysis (GTA), uses a unique set of time frames matched with trend models to identify support and resistance levels. Markets behave in different ways based on different time periods and participants. For example, institutional investors tend to make long-term investments quarterly. GTA analysis reports on quarterly, monthly, weekly, and daily trends. The following chart shows ES futures contract prices are below Monthly and Weekly Trends. The model notes a one period or two-period move as below trend.  When ES future prices make three consecutive period moves, a trend is indicated for that timeframe.

Source: Brett Freeze, Global Technical Analysis – 10/15/21

Note: PQH = Previous Quarter High, PQL = Previous Quarter Low, PMH = Previous Month High, PML = Previous Month Low, PWH = Previous Weekly High, PML = Previous Weekly Low, PDH = Previous Daily High, PDL = Previous Daily Low

Realized Volatility Is Relatively Low, Yet Implied Volatility Is Rising

Realized volatility is the change in price between the daily closes of a stock, ETF, or financial instrument.  The following chart from Lance Roberts and CNBC shows how price changes in the S&P 500 have been above average but are still within a 2% daily range since the March 2020 SPX lows.

Source: Real Investment Advice – 10/6/21

Realized volatility shows how market participants are actually driving market price swings by direct trading.  The limited movement of realized volatility obscures the impact of implied volatility of markets.

Implied Volatility

Implied volatility is the range of prices based on speculation of where a price may be for underlying security or index at a specific date. Overall implied volatility has been climbing the past few years.  The Volatility Index (VIX) is an indicator of implied volatility. The Chicago Board Options Exchange developed the VIX as a real-time index representing market expectations for the relative strength of near-term price changes of the S&P 500 index (SPX). It is calculated based on the ratio of puts (an option to sell underlying security) to calls (an option to buy underlying security) for near-term (30 days or less) options contracts.

VIX – Bullish or Bearish?

The lower the VIX index and the more calls to puts is considered bullish.  Conversely, the more puts to calls driving and higher VIX is deemed to be bearish.  The VIX uses put and call options set at specific strike price levels that traders speculate the SPX maybe, not the actual SPX index value. The VIX is one gauge of market sentiment on the direction of prices for the SPX.  Over the past several years, the baseline VIX has been climbing as the SPX has rallied.  Higher lows indicate growing anxiety about high valuations.  The following monthly chart shows the VIX levels since 2014 with higher lows (red arrow) as it spikes at market lows like March 2020.

Source: Patrick Hill – 10/16/21

The VIX reached a low of 9.51 in 2017 and today stands at 16.30 on October 15th as a rally continues.  The VIX reached a high of 53.54 at the SPX March 2020 decline. It would seem with higher lows that a higher spike is possible. Daily options market volume as of September is higher than the volume of underlying stocks. This means that speculation on where the SPX level will be is overtaking market flows.

Options Levels Point to A Volatility Storm Zone – Below 4400

Options analysts note last week’s bounce in S&P 500 Index is likely due to traders selling put options at monthly expiration, which crushed implied volatility.  The VIX indicator fell to 16.80 from 20. Dealers began setting up ‘short volatility positions and buying calls supporting the rise in market prices. SPX levels of open interest in puts and calls identify where there may be support or resistance to prices.

The following chart shows a gamma pivot point at 4400.  Gamma is the rate of change of the delta or sensitivity of the option price to a $1 change in the underlying stock price.  It measures the rate at which dealers must adjust their hedged positions. Positive gamma is above 4400, where there are more calls than puts and traders are net-long options.  As a stock price goes up, the dealer sells the stock and buys it as it goes down.  Dealers dampen price changes in a positive gamma environment.

Conversely, when a dealer is net short options, they must hedge by selling the stock as it goes down and buying the stock as price rises triggering increased volatility.  Today, 4400 is the pivot point between positive and negative gamma. Below 4300, we added a Volatility Zone where a volatility storm may build. The chart shows total open interest with puts below the zero line and calls above, with current expiration darkly shaded.

Sources: and Patrick Hill – 10/15/21

Watch out Below 4400

Brent Kochuba, a co-founder of SpotGamma, notes likely increased volatility below 4400,

 We currently see fairly light put positions below 4400. This implies that traders may need to purchase put options on a break of 4400, which could in turn force options dealers to short futures. This could lead to dealers shorting into a down market, which increases volatility.”

We have located where the volatility storm may develop. But, what factors might trigger a storm?

Factors Triggering a Volatility Storm

The critical triggering events will be Federal Reserve tapering and interest rate increases planned for 2022.  The financial markets depend on high levels of liquidity, so any reduction in liquidity could act as a catalyst for a volatility storm.  Other factors that may magnify a liquidity crunch include:

  1. The debt ceiling not being raised in December

  2. Options hedgers overreach and can’t cover margin positions, triggering forced selling

  3. Inflation roaring further ahead beyond the Fed’s ability to control it, so the market loses confidence in the Fed

  4. The Fed raises interest rates higher and faster than the market expects

  5. Consumers quit spending, causing retail sales to drop, corporations sales fall, and stock buybacks end that were sustaining high market valuations

  6. The economy goes into a recession as GDP drops, employment falls, and corporate valuations fall

  7. Any black swan event like the pandemic

Any volatility storm as markets decline is likely to force analysts to shift from valuing stocks based on market speculation to actual GAAP earnings (not stock buyback inflated EPS), fundamentals, and related unused valuation tools.  The TINA – ‘there is no alternative’ trading phenomenon would be over.  Investors will need to be mindful of the extreme volatility posed by a volatility storm. Accordingly, wild rallies and steep falls will require portfolio managers to sharpen their hedging and volatility strategies to maintain portfolio value.

Tyler Durden
Thu, 10/21/2021 – 08:04

Author: Tyler Durden

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Lira Crashes To All Time Low After Turkey Shocks With 200bps Rate Cut Despite Soaring Inflation

Lira Crashes To All Time Low After Turkey Shocks With 200bps Rate Cut Despite Soaring Inflation

To be fair, the writing has been on the wall…

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Lira Crashes To All Time Low After Turkey Shocks With 200bps Rate Cut Despite Soaring Inflation

To be fair, the writing has been on the wall for the past three years, ever since Turkey’s authoritarian ruler and de facto central bank head Erdogan started firing Central Bank governors any time they refused to cut rates to fight inflation in compliance with Erdoganomic, a reminder of which we got just last week when Erdogan fired three more Turkish central bankers, sending the lira plunging…

… in a move which we suggested that one way or another, Erdogan wants hyperinflation, and currency collapse.

So fast forward to this morning when central bankers, knowing they would lose their jobs if they didn’t slash rate by even more than the market expected (and the market expected a generous 50-100bps) cut despite the highest inflation in over two years (the latest CPI print came in at 19.58%), had no choice but to slash and they did just that and Turkey’s Central Bank cut its one-week repo rate by 200bps, from 18% to 16%, double what consensus expected (15 of 26 economists in Bloomberg’s survey expected 17.00%, with the rest expecting a 50bps cut), arguing inflation is “transitory” if adding that it has limited room left for further reductions this year (actually no, it will keep cutting because that’s what Erdogan wants).

The “recent increase in inflation has been driven by supply side factors,” the central bank said, calling them transitory. “The Committee assessed that, till the end of the year, supply side transitory factors leave limited room for the downward adjustment to the policy rate.”

Putting the rate cut in its (hyperinflationary) context, the rate cut virtually guarantees that Turkish inflation is about to turn even more hyper :

In a hilarious twist, the TCMB justifed this insane move by pointing the finger to “advanced economy” central banks and arguing that since they see inflation as temporary – and since the Fed continues to inject hundreds of billions of liquidity every month – surely inflation must be transitory, and so Turkey can surely afford a rate cut, to wit:

Central banks in advanced economies assess that the rise in inflation would be mostly temporary along with normalization in demand composition, easing of supply constraints and waning base effects. Accordingly, central banks in advanced economies continue their supportive monetary stances and asset purchase programs

Recent increase in inflation has been driven by supply side factors such as rise in food and import prices, especially in energy, and supply constraints, increase in administered prices and demand developments due to the reopening. It is assessed that these effects are due to transitory factors

All one can do here is laugh. Anyway, here are some more “explanations” for the shocking cut:

Despite the recovery in global economic activity in the first half of the year, recently published confidence indices have started to decline due to the effect of the pandemic….

The MPC assesses that, until the end of the year, supply-side transitory factors leave limited room for the downward adjustment to the policy rate.

Leading indicators show that domestic economic activity remains strong, with the help of robust external demand… Improvement in annualized current account is expected to continue in the rest of the year.

Meanwhile, the “tightness in monetary stance has started to have a higher than envisaged contractionary effect on commercial loans. Strengthened macroprudential policy framework has started to curb personal loan growth.” Or said otherwise, if we don’t cut, the big bogg will fire us all.

In parting, the TCMB said that the “Bank will continue to use decisively all available instruments until strong indicators point to a permanent fall in inflation and the medium-term 5% target is achieved.”

Not surprisingly, now that it is abundantly clear that Erdogan will sacrifice the lira before he admits he has been wrong all along, the TRY crashed to a new all time low, plunging as much as 2.9% to just shy of 9.50 vs the USD, a move which we are confident will only accelerate to the downside with Erdogan having openly invited hyperinflation, and only a popular uprising having some chance of halting this catastrophic turn of events, yet a revolution will hardly be lira positive and as such expect much, much more weakness in the now doomed currency.

The cut “can be interpreted as a very strong message to market participants that the central bank intends to ease monetary policy regardless of negative consequences of the precipitous fall in the value of the lira,” said Piotr Matys, a senior currency analyst at InTouch Capital in London, echoing what we said one week ago.

“Today’s decision is an obvious disregard of warnings the market has already sent the CBRT that lowering rates – when inflation is close to 20% and core inflation cannot be used as a valid argument to cut rates – is a policy mistake,” Matys said, referring to the central bank by its English-language acronym.

Erdogan’s central bank puppet, Kavcioglu will update the bank’s base-case scenario for inflation through the rest of 2021 and the following two years on Oct. 28, and answer questions from economists and reporters. The central bank currently sees consumer-price growth finishing the year at 14.1%, a more optimistic forecast than the government’s latest estimate of 16.2%. In reality, expect hyperinflation.

Tyler Durden
Thu, 10/21/2021 – 07:26

Author: Tyler Durden

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