I’ve spoken to people in the primary dealer community. They’re completely relaxed because they’re just middle-men; they’re intermediaries between the Fed and the banks; the institutional investors. They buy bonds from the Treasury, they can finance them or sell them to the Fed or they can sell them to institutions. So the primary dealer is basically the large banks are middle-men.
Now, the risk there is that they’ll get caught out. They’ve got long maturities, so they’ve got five-year notes or ten-year notes and they’re financing them overnight in the repo market. Well, what if the repo rate went up? All of a sudden the trade is profitable, it goes upside down, if the short-term rate gets above the long-term rate. Or if long-term rates go up they have capital losses on the bonds.
So it’s a very risky trade, but the Fed has told them, “We’ve got your back.” That’s what forward guidance is. When the Fed says “We’re not gonna raise rates for two years or three years, etc., then you can do the overnight financing for three years and know that you’re going to be paying zero rates.”
So they’ve taken the risks out of the trade. So the primary dealers are relaxed, the Fed is going to keep the lid on the interest rates.
So it’s a very risky trade, but the Fed has told them, “We’ve got your back.” That’s what forward guidance is. When the Fed says “We’re not gonna raise rates for two years or three years, etc., then you can do the overnight financing for three years and know that you’re going to be paying zero rates.”
So they’ve taken the risks out of the trade. So the primary dealers are relaxed, the Fed is going to keep the lid on the interest rates.
- Source, Future Money Trends:
