Another repo market liquidity injection for gold bulls to cheer

Last September, in a response to the repo crisis, the Fed started again buying assets (but do not call it quantitative easing, this is, wink, wink, something different). Actually, the recent liquidity injections have already reversed all the tightening that occurred earlier in 2019. The Fed added more than $400 billion to its balance sheet, raising it from the lows of $3.76 trillion up to $4.165 trillion at the end of December. And Thursday’s move will add even more to the Fed’s balance sheet!

What is important is that the liquidity shortage in the US repo market was not a one-off event, but that it has become a structural problem. As the December report from the Bank of International Settlements explains,

To simplify, there is too little cash and too many government bonds. Well, traders can thank President Trump who has increased significantly the fiscal deficit. As the Congressional Budget Office estimated last week, the federal deficit rose 12 percent in the first quarter of fiscal year 2020 compared to the same period last year. A larger deficit means more Treasuries coming into the market, putting upward pressure on interest rates.

The additional cash injections from the Fed are fundamentally positive for the gold market. First, they act similarly to an additional interest rate cut. Second, they suggest that the financial market is less liquid and healthy that it might seem at first sight. They show that the liquidity shortage has not ended – and that it could trigger an important turmoil in 2020. Gold should shine then!

And let’s not forget about the crazy fiscal policy. So, it might be the case that 2020 will be, after all, better for the gold prices than we previously thought. We expected less insane fiscal policy, but with such huge deficits, the macroeconomic outlook for gold looks more optimistic. However, it’s a bit too early to radically change our view.