I work for Alhambra Investments.

I'm the head of global research there.

It's a registered investment advisor based out of Florida.

What I do is, as the head of global research, is I focus in on the monetary mechanics, the

plumbing, so to speak, behind what actually goes on in the world.

I take a particular focus on something I call the Eurodollar system because as a global

currency, it really is the global reserve currency.

Because it's a global reserve currency, what that does is that touches pretty much every

part of the global economy in almost every part of the global markets.

The way in which that happens is it's a lot of times very complex.

A lot of times, it's hard to decipher, but what you should know is that the Eurodollar

system is everywhere.

It's out there, it's happening, it goes on, and very few people pay attention to it, and

a few still understand what really means and what it really does.

It was way back in early part of my career, I started looking at bank balance sheets,

for example, as an equity analyst, as a return a portfolio management firm.

You take a look at banks, and what you found out was that the way the banks operate and

the way that individual banks balance sheets were put together was not what you were taught

in school.

There was all the things going on, on these balance sheets and in this monetary system

that was very different from what everybody was saying, what everybody believed in and

so I started investigating that.

What really drove me to look at it was the fact that nobody had any answers for these

things.

These things would happen, you could see them on balance sheets, and you could see that

there was more behind them but when you stop to talk to people who were supposedly in the

know, people were supposed to know these things.

You listen to central bankers and economists, for example, it was very clear they didn't

have a very good understanding.

For me, it just drove me further and further that hey, maybe someday this will be important.

Of course, first you had the dot-com bust and then of course, what happened in 2008.

You started really to think, okay, there's something really going on here that's worth

investigating and worth understanding in a particular level, because there's a lot that's

attached to it.

Well, what literally happened last week was the repo rate shot up.

Because it shot up, there's various linkages between the repo market and the Federal Funds

market.

Monetary policy at the Federal Reserve operates on Federal Funds so as Federal Funds rose

in the range, and then actually broke out of the target policy range, that caught the

Fed's attention.

They can't any longer ignore something going on the repo market that's spilling over into

Federal Funds.

That's literally what happened, was that these report rates skyrocketed because of a lack

of liquidity, which forced the Fed to respond, which they did with these overnight repo operations

that have become daily, which are now sprinkled in with term repo operations simply because

there's a lack of liquidity in the system.

We're not really sure why.

The Fed doesn't know, most people in the mainstream don't know, there's really not a whole lot

of answers about what's really going on there.

There's certainly been a lot of theories, but there hasn't been a lot of answers.

For what I said, what I've been saying for a long time is that this didn't just happen

out of the blue.

We've been talking about Fed funds repo, for in this particular case, for over a year and

a half.

In fact, the Federal Reserve knew something was going on because they have been altering

their mechanics, just a little slightly here along the way.

Going back to June of last year, for example, June of 2018, they changed IOER for the first

time.

They dropped it five basis points below where it was.

The idea was that that would help liquidity in the marketplace, that would get banks to

lend some of their free reserves into essentially repo and then have that trickle down into

Federal Funds.

That never happened.

They kept on adjusting IOER expecting that this little nothing of a problem would just

go away.

They kept finding out that, hey, there's something going on here.

There's something else going on here.

Really, that's the big message behind all of this.

When you stop and look at what's going on in the repo market, Federal Funds and some

of the wider issues with the fixed income marketplace as a whole, what you keep coming

back to is there's something going on here.

First, you say there's something missing.

Obviously, there's something missing.

We saw that last week.

There's a big piece of liquidity missing, but there's something else going on here because

this keeps building and building, and what happened last week was it finally broke out

into the open so that everybody started paying attention to what was essentially something

that had been happening for quite some time beforehand.

IOER is the rate the Fed pays on excess reserves.

Going back to 2008, the Fed has created excess bank reserves and it pays a specific rate

on those reserves to the banking system.

The idea is that helps the Fed control money market rates like the Federal Funds rate.

The reason it is because where they place IOER in the range of their policy range or

in the range of actual transactions gives banks alternatives of where they can put free

cash or free funds, however you want to call bank reserves.

The idea is if I lower IOER, that means I'm going to pay banks-- as the Fed, I'm going

to pay the banks a little bit less to give them a little bit more incentive to go into

repo or Federal Funds that will bring those rates down and add a little bit more liquidity

to the system where it's supposedly needed.

That didn't happen.

Every time they reduced IOER, you didn't see much of a response in either repo or Federal

Funds.

Federal funds kept rising inside the range.

In fact, earlier March of this year, Federal Funds broke above IOER for the first time

and they responded by just lowering IOER again expecting, again, the idea that will pay banks

a little bit less on their reserves so that they'll chase a higher return which was by

then a much higher return in Federal Funds and repo.

Again, we come back to that same question, why didn't the banks do that?

Where were they?

What are we missing here?

Thanks for not taking that advantage of what should have been of much higher incentives

to add liquidity into repo and Federal Funds and these other places.

They weren't doing it.

What we're really talking about here is banks being constrained.

The reason they're not going into these marketplaces is because they don't want to there.

There's something else going on in the system.

I think it goes back to last year.

If you look at May 29th , 2018 for example, what happened on May 29th , 2018 was nothing

more than interest rates tumbling.

They fell sharply.

What that said was that the market was concerned about something.

Something happened on May 29th . We may not know exactly what it is, but because it wasn't

just US Treasury yields, you had German bond yields and other yields of sovereign bond

yields around the world tumbling on May 29th, what it did was it announced that something

had just happened in the global system.

Again, we're talking about a global reserve currency, therefore a global monetary system.

Something happened on May 29th that wasn't good that forced mostly banks in the system

to buy and value Treasury bonds, German bonds, those types of instruments.

What happened after that point is, and you see this in all of the charts, all the charts

that matter anyway, May 29th turned out to be an inflection point.

Everything changed after.

Inflation expectations for example, before May 29th, it was going along the way-- the

TIPS market was going along the way that Jay Powell said it was.

The economy was booming, everything was great, we're going to have an inflationary breakout,

inflation expectations in the TIPS market were rising.

May 29th happens, that's no longer the case.

Inflation expectations plateaued and then they have been falling ever since.

Something changed on May 29th, and because it was US Treasury bonds, because it was German

bonds, what that suggests is that there was a problem in collateral, which is the other

side of the repo market.

The repo market has a cash side and also has a collateral side.

You can't go in the repo market and fund whatever you're trying to do if you don't have the

acceptable collateral that the repo market's looking for.

What we know from May 29th is something happened, and likely happened in the collateral system,

that ever since that point, ever since May 29th of last year, these banks, this global

banking system, this global monetary system has been increasingly reluctant to respond

whenever you see these other opportunities, let's call them, to offer liquidity to offer

to funds.

They don't want to do it, they're staying out of it.

Again, something's missing, something is absent.

I think a lot of it has to do with the collateral side in the repo market.

The collateral side is not an easy thing to explain because it's one of those things,

it's part of the global framework of modern money.

It's just, again, the stuff that you were never taught in school how it actually works.

It's a very complicated, almost bizarre, weird place.

A lot of different things happen on the collateral side.

It's something called securities lending, but even the idea of lending securities is

probably foreign to most people because it sounds fantastic.

Why would you be lending securities?

Oh, by the way, we're not just lending securities, we're also transforming securities.

We have collateral lending, we have rehypothecation, we have collateral transformation, we have

all these weird things going on, that these dealer banks know is going on.

Not only do they know what's going on, they probably have a decent idea of who it's going

on with and they also have an idea of how much this is taking place.

If there's an issue in the collateral system, we can suspect, again, we don't have any direct

evidence for these things because it's hidden in these offshore spaces of this global marketplace.

We can begin to suspect by what we see in market prices and dealer bank behavior that

there's some concern about all of the things that were going on the collateral side of

the repo market, may be in danger of creating bigger problems.

That might answer, in my view, probably does answer at least a good part of why dealers

are reluctant to step in when they should be stepping in, when they should be taking,

hey, I got lower IOER, why am I not taking advantage of the spread to repo or Federal