Weekly market update

The major averages finished the week lower as the “Wall of Worry” grows higher.

The Dow fell 1.04%, the S&P 500 gave up 0.49% and the NASDAQ lost 0.71%. Many of the same worries were on investors minds, trade, the FED, inverted yield curves, Middle East tensions, but we got something new to worry about last week that many are unfamiliar with. If the FED didn’t already have enough on its plate heading into last week’s FOMC meeting on interest rates and monetary policy, chaos deep inside the “plumbing” of the U.S. financial system threw policymakers an unexpected curveball.

Cash available to banks for their short-term funding needs all but dried up on Monday and Tuesday, and interest rates in U.S. money markets shot up to as high as 10% for some overnight loans, more than four times the FED Funds rate.

That forced the FED to make an emergency injection of more than $50 billion, its first since the financial crisis more than a decade ago, to prevent borrowing costs from spiraling even higher. It conducted another one on Wednesday.

The exact cause of the squeeze is a matter of some debate, but most market participants agree that two coincidental events on Monday were at least partly to blame. First, corporations had to withdraw funds from money market accounts to pay for quarterly tax bills, and then on the same day the banks and investors who bought the $78 billion of U.S. Treasury notes and bonds sold by Uncle Sam the prior week had to settle up.

On top of that, the reserves that banks park with the FED and are often made available to other banks on an overnight basis are at their lowest since 2011 thanks to the central bank’s culling of its vast portfolio of bonds over the past few years.

Added together, these factors are testing the limits of the $2.2 trillion repurchase agreement—or repo—market, a gray but essential component of the U.S. financial system.

Whatever the cause, the episode has added fuel to the argument that the FED needs to take steps to avoid more disruptions in the repo market down the road. This is something that we will be monitoring very close over the days and weeks to come.

Turning to the FED—last week the Federal Reserve delivered a highly anticipated rate cut, the second this year. Although the rate cut was welcomed, by most, forward guidance was a bit mixed (I said last week that the press conference would be more important than the actual cut itself). For the most part, their statement was dovish, with little changing or signaling that this will be the last cut. Moreover, 7 of the 10 voting members were in favor of the cut.

However, during the press conference, Chairman Powell appeared to confirm that this was part of a mid-cycle adjustment, which suggest a more hawkish stance. So, overall, the message the Federal Reserve seemed divergent and paints an unclear picture on whether we will have zero, one or multiple cuts ahead.

Given the lack of clarity about the FED’s next move, in addition to all of the other market uncertainties, we should be prepared for more volatility ahead.

We urge you to stay tuned and we’ll keep you posted and if you have any questions, comments or concerns how these and other events impact your own particular situation, please let us know so we can address. Have a great week—and hello Fall.

Todd Day, MBA
Portfolio Manager
Horizon Financial Services, LLC

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