Big Short Burry warns: Fed's RMP aims to cover up banking system vulnerabilities, essentially restarting QE

Michael Burry warns that the Federal Reserve has effectively restarted QE under the guise of "Reserve Management Purchases," exposing the banking system's ongoing reliance on central bank liquidity for survival.

Written by: Zhang Yaqi

Source: Wallstreetcn

Michael Burry, the real-life inspiration for the film "The Big Short," has issued a stern warning regarding the Federal Reserve's latest bond-buying plan. He points out that what is called "Reserve Management Purchases" (RMP) in fact reveals the deep-seated fragility of the US banking system. He believes this move is essentially a restart of quantitative easing (QE), intended to mask the liquidity crunch facing the banking sector, rather than being a routine operation as the Fed claims.

According to a previous article by Wallstreetcn, the Federal Reserve announced overnight that it would begin purchasing short-term Treasuries as needed to maintain an ample supply of reserves. The New York Fed simultaneously issued a notice, planning to buy $40 billion in short-term Treasuries over the next 30 days—its latest move since officially ending balance sheet reduction last week. This comes against the backdrop of unsettling rate volatility in the $12 trillion US repo market, with ongoing turmoil in money markets forcing the Fed to act more swiftly.

However, Burry believes this action precisely indicates that the banking system has yet to shake off the aftershocks of the 2023 small bank crisis. He warns that if the banking system still needs central bank "lifeblood" despite holding over $3 trillion in reserves, this is by no means a sign of strength, but rather a strong signal of systemic fragility.

Burry further analyzes that each round of crisis seems to force the Federal Reserve to permanently expand its balance sheet, or else risk triggering a banking funding crisis. The subsequent market reaction confirmed the tightness of liquidity: the yield on the US 2-month Treasury note jumped, while the 10-year Treasury yield fell. Meanwhile, volatility in the repo market persists, sparking concerns about year-end funding squeezes and forcing investors to reassess the stability of the financial system.

Covert Quantitative Easing and a Fragile Banking System

Burry questioned the Federal Reserve's use of the term "Reserve Management Purchases," interpreting it as a covert move aimed at stabilizing a banking sector that is still struggling. According to FRED data, before the 2023 crisis, US bank reserves stood at only $2.2 trillion, but have now climbed to over $3 trillion.

Burry issued a warning:

"If the US banking system cannot operate without more than $3 trillion in reserves or Federal Reserve 'life support,' this is not a sign of strength, but a sign of fragility."

He added that the current pattern seems to have evolved into the Fed needing to permanently expand its balance sheet after every crisis, or else face the risk of a banking funding chain rupture. While this mechanism partly explains the strong performance of the stock market, it also reveals the financial system's extreme dependence on central bank liquidity.

Market Operation Mismatch and Hedging Strategies

On the operational level, Burry emphasized a significant strategic shift between the US Treasury and the Federal Reserve: the Treasury prefers to sell more short-term bills, while the Fed focuses on buying these bills. This strategy helps avoid pushing up the 10-year Treasury yield. As the market expected, after the Federal Open Market Committee (FOMC) meeting, the yield on the US 2-month Treasury rose, while the 10-year Treasury yield fell.

Given the ongoing volatility in the repo market, some analysts expect the Federal Reserve may need to take even more aggressive action to avoid a year-end funding squeeze. Against this backdrop, Burry sees further evidence of underlying weakness in the financial system. He warns investors to be wary of misleading Wall Street advice to buy bank stocks, and reveals that for funds exceeding the Federal Deposit Insurance Corporation (FDIC) $250,000 limit, he prefers to hold Treasury money market funds to mitigate risk.

It is worth noting that the main goal of "quantitative easing" (QE) is to lower long-term interest rates by purchasing long-term Treasuries and MBS, thereby stimulating economic growth. In contrast, RMP is more technical in nature, focusing on buying short-term Treasuries to ensure sufficient liquidity in the financial system's "pipes" and prevent accidents. According to Bank of America, based on the experience of 2019, liquidity injections will quickly push down the Secured Overnight Financing Rate (SOFR), while the federal funds rate (FF) will react more slowly. This "time lag" will create significant arbitrage opportunities for investors.