I’ve been learning about the plumbing that underlies the financial system. It’s all to do with repo rates, excess reserves, primary dealers, and T-bill balances. I used to work in this niche when I was at Salomon Brothers. I won’t bore you with the details.

The most important things I’ve observed are that the federal funds rate has moved above the IOER rate, and the eurodollar curve has inverted out to five years.

If you’ve never heard of a “eurodollar,” the easiest definition is that it’s a dollar that exists and circulates outside the U.S.

They’re called eurodollars because London – where this market first bloomed – is in Europe. But dollars on deposit in Tokyo or São Paulo are also called eurodollars.

The IOER rate is the Fed’s main policy tool for manipulating the fed funds rate. IOER stands for “interest on excess reserves.” It was supposed to be a “ceiling” the federal funds rate (FFR) would never go above.

We won’t get into the detailed explanation of what I’m seeing. But here’s the important thing to know: That the FFR has gone above the IOER must mean banks have no excess reserves. Otherwise, the banks would arbitrage the FFR back down below the IOER.

That the eurodollar curve has inverted out to five years shows banks are bidding on collateral they can use in repo markets.

Another way of putting this is that conditions have become so tight in the banking system, you could call it a slow-motion credit crunch.

The Fed needs to reliquify the banking system ASAP, or there’ll be trouble. This is why the Fed is beginning a rate-cutting cycle, even though the stock market is at all-time highs, unemployment is at 60-year lows, and inflation is near the Fed’s target.

I expect the Fed to curtail quantitative tightening (QT) soon, too, and begin quantitative easing (QE). And it’ll probably introduce a new tool to control the fed funds rate, probably a repo facility.

The Fed’s next meeting is July 30-31.

Tom Dyson

P.S. We’re in Goa. It’s monsoon season.

The streets are muddy, the sea is too rough to swim in, and everything’s closed. There are no tourists. We’re holed up in a one-star hotel room above a restaurant called “The Curry House.”


Two of Tom’s kids in front of “The Curry House”

It’s been raining all day and all night.

The kids are doing their homework and watching TEDx speeches. I’m writing journals and studying economics. Kate is doing laundry in a bucket.

If the rain breaks, we’ll venture outside to get supplies – water, ramen noodles, cookies, cereal, and fruit.

Otherwise, we’ll order room service – veggie burgers, fries, Singapore noodles, curries, and garlic naan bread. (We’ll be able to smell it cooking if we open the windows.)

We paid for seven nights up front. Unless we want to forfeit our money, we’re stuck here.

It’s okay. We’re used to living like this now.

We couldn’t have done a better job of scrambling our lives. We’re divorced. We have no possessions (we sold everything a year ago). We have no place to live. Our kids have never been to school. I quit my job.

We have become a sort of modern gypsy family.

We love living like this, but we can’t help thinking: What does the next chapter look like for us?

For now, we’re having a great time in India. We’re trying not to worry about our future.

The Dow-to-Gold ratio is at 18.9. Gold is at $1,439. The Dow is at 27,192.