Big short Burry warns: The Federal Reserve's RMP aims to cover up the fragility of the banking system and is essentially a restart of QE

Michael Burry, the prototype of the movie "The Big Short," issued a stern warning regarding the Federal Reserve's latest bond-buying plan, pointing out that its name, "Reserve Management Purchases" (RMP), actually exposes the deep vulnerabilities of the U.S. banking system. He believes that this move essentially restarts quantitative easing (QE) and aims to cover up the liquidity crunch faced by the banking system, rather than being a routine operation as claimed by the Federal Reserve.

According to a previous article from Wall Street Insight, the Federal Reserve announced overnight that it would begin purchasing short-term government bonds as needed to maintain sufficient reserves. The New York Fed simultaneously released a statement planning to buy $40 billion in short-term government bonds over the next 30 days, marking the latest action since officially halting balance sheet reduction last week. This move comes in response to unsettling interest rate fluctuations in the U.S. repurchase market, which has reached a scale of $12 trillion, forcing the Federal Reserve to accelerate its actions amid ongoing turmoil in the money market.

However, Burry believes that this action precisely indicates that the banking system has still not shaken off the aftershocks of the 2023 small bank crisis. He warned that if the banking system requires "blood transfusions" from the central bank despite having over $3 trillion in reserves, this is not a sign of strength but a strong signal of systemic weakness.

Burry further analyzed that each round of crisis seems to force the Federal Reserve to permanently expand its balance sheet; otherwise, it cannot avoid the outbreak of a banking financing crisis. The subsequent market reaction validated the tightening of liquidity, with the yield on U.S. 2-month Treasury bonds jumping while the yield on 10-year Treasury bonds fell. Meanwhile, volatility in the repurchase market persisted, raising concerns about year-end financing tightening 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" and interpreted it as a covert measure aimed at stabilizing the struggling banking industry. According to FRED data, before the 2023 crisis, the reserves of U.S. banks were only $2.2 trillion, while they have now risen to over $3 trillion.

Burry issued a warning:

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

He added that the current model seems to have evolved into a situation where the Federal Reserve needs to permanently expand its balance sheet after each crisis, or else face the risk of a banking liquidity crisis. While this mechanism somewhat explains why the stock market has performed strongly, it also reveals the financial system's extreme dependence on central bank liquidity.

Market Operation Mismatch and Hedging Strategies

From a specific operational perspective, Burry emphasized the significant strategic shift between the U.S. Treasury and the Federal Reserve: the Treasury tends to sell more short-term securities, while the Federal Reserve focuses on purchasing these securities. This strategy helps avoid pushing up the yield on 10-year Treasury bonds As the market expected, after the Federal Open Market Committee (FOMC) meeting, the yield on the 2-month U.S. Treasury rose, while the yield on the 10-year Treasury fell.

Given the ongoing volatility in the repurchase market, some analysts expect that the Federal Reserve may need to take more aggressive actions to avoid a tightening of funds by the end of the year. In this context, Burry believes this is further evidence of underlying weakness in the financial system. He warns investors to be cautious of misleading advice from Wall Street about buying bank stocks and reveals that for funds exceeding the Federal Deposit Insurance Corporation (FDIC) limit of $250,000, he prefers to hold Treasury money market funds to mitigate risk.

It is important to note that the main goal of "quantitative easing" (QE) is to lower long-term interest rates by purchasing long-term Treasuries and MBS to stimulate economic growth. In contrast, the purpose of RMP is more technical, focusing on purchasing short-term Treasuries to ensure there is enough liquidity in the "pipeline" of the financial system to prevent accidents. Bank of America stated that based on experiences from 2019, liquidity injections will quickly lower the secured overnight financing rate (SOFR), while the response of the federal funds rate (FF) will be relatively lagging, creating significant arbitrage opportunities for investors due to this "time lag."