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As Stocks Race to Record Highs, these 2 Things Could Scare Investors Straight

Last Updated September 23, 2020 1:12 PM
Sam Bourgi
Last Updated September 23, 2020 1:12 PM
  • S&P 500 Index came within half a point of record highs on Friday.
  • New York Fed has increased the size of its overnight repo operations to at least $120 billion.
  • U.S. budget deficit approaches $1 trillion in 2019, the highest in seven years.

With U.S. stocks fast approaching record territory, investors may have lost sight of the fact that the Federal Reserve is still injecting hundreds of billions of dollars into the overnight lending market. There doesn’t appear to be anything ‘temporary’ about its actions, either.

There’s Nothing Temporary About the Fed’s Repo Operations

Earlier this week, the New York Fed announced  it was going to increase the size of its overnight repurchase operations to at least $120 billion, up from $75 billion previously. It also increased the size of its term repo operations to at least $45 billion. That’s on top of the $60 billion in Treasury bills the central bank has vowed to purchase on a monthly basis.

The problem – a severe liquidity shortage in the overnight lending market that drove interest rates to as high as 10% – first reared its ugly head in September. At the time, central bankers said their emergency repurchase agreements were meant to provide temporary relief to the financial system. More than a month later, there’s no signs that this new form of ‘not-QE’ is ending anytime soon.

The seemingly permanent liquidity boost comes as the federal budget deficit  has swelled to nearly $1 trillion this year, the highest since 2012. It also comes at a time when the Federal Reserve is aggressively cutting interest rates to save the economy from nosediving. As it turns out, it may be too little, too late.

Federal Open Market Committee (FOMC) members are widely expected to lower interest rates again next week, according to CME Group’s FedWatch Tool . Futures traders have placed the odds of another quarter-point rate cut at 93.5%.

Federal Deficit Spikes 26%

The U.S. Treasury announced Friday that the size of the federal deficit has increased 26% in fiscal 2019, reaching a colossal $984 billion. That’s the highest since 2012.

Washington’s deficit has been aggravated by massive bipartisan spending bills and President Trump’s landmark tax reform. While the tax cuts were certainly welcomed, they weren’t accompanied by commensurate cuts in government spending. That left Washington with less tax revenues to fund existing programs.

President Trump vowed that the tax cuts would pay for themselves through added growth, but the track record so far doesn’t look good. The U.S. economy has been mired in a protracted slowdown, with Q3 2019 expected to be the weakest quarter of growth since the end of last year.

US GDP growth
Is the U.S. economy running out of steam? The Atlanta Fed’s latest projections point to a soft landing. | Chart: tradingeconomics.com

Latest estimates from the Atlanta Fed peg third-quarter growth at just 1.8% annually. The economy slowed to a 2% annual growth rate during the second quarter.

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