Dividends and Why excess cash in the system may be bad news for investors

Every work day after 4 pm when markets close, banks do an inventory of how cash they have and invest in with the central bank in a operation called reverse repo. The money is parked with the Federal Reserve and all is good with the banking system for another day.

The issue is the size of the operation, in an article by Ian McGuggan , the size is about half a trillion dollars a day.

The size can be seen as a warning sign that the Fed’s program to pump cash into the economy has tipped to too much and it needs to be rebalanced or the Fed will taper its cash stoking tactics. The easiest method to do that would be raise rates a bit. The Fed has said they will continue the course until the economy is fully healed for those who were hurt the most.

The Fed has been buying $120 billion a month of Treasury and mortgage bonds since June 2020. The idea and it has worked is to hold down longer term interest costs by bidding up the price of bonds (remembering bond prices and yields work in opposite directions).

Much of the surplus cash appears to be going into reverse repos. A reverse repo is the Fed sells Treasury securities to a financial institution with the promise it will repurchase the securities the next day. This takes cash off the financial institution’s balance sheet overnight and turns it into an asset.

In today’s low interest rate environment the trade is a wash in terms of profit and loss as the repurchase takes place at the same price of the original sale. Why do it? without them the interest rate would sink into negative territory, according to Robert Armstrong writing in the Financial Times.

Oliver Allen, markets economist at Capital Economics wrote one of the reasons why bond yields are staying low is the portfolio adjustments by the large US banks. Regulations to ensure banking safety means banks are required to hold large amounts of high quality liquid assets, such as Treasury bills. Given that central bank reserves and reverse repos are near zero, the banks may be buying US Treasuries instead.

Mr. Allen believes by year end the 10 year Treasury will be yield 2.25%.

Linking to dividend paying stocks, there are many elements which affect the market and those in the industry look to a wide range of metrics. As a smaller investor these things are good to know but you can judge your company how long it has been profitable and can pay dividends. Then you can determine how the biggest divisions are doing, if you believe the divisions are doing well, there is little to do and that can be a very good thing for you can focus on family and summer.

There are more questions than answers, till the next time – to raising questions.

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