Citi’s Matt King has some harsh words for central bankers ahead of this week’s gathering in Jackson Hole, Wyoming: he says they’ve broken the market.
King echoes a group of fund managers who say central banks’ stimulus efforts are distorting the way global markets function. The problem is this: with negative yields on $13 trillion of safe assets, investment managers are crowding into the shrinking group of investments with yield — or into securities they may be able to sell to central banks. Read more
To those living outside London — Tube commuters have had a decades-old system of standing on the right of escalators and allowing highly-strung travellers to pass by on the left. Holborn station has been encouraging people to stand on both sides of the escalator, to find out if that system reduces overcrowding and would actually get people out on to the street faster.
This may seem a mere counterintuitive curiosity, but the dynamics at play are very much the same as those facing investors in bond funds and mass redemptions. Or rather, one way to understand the fears about bond market liquidity is to understand how people use escalators in London. Read more
The Federal Reserve insists there is nothing wrong with the $14tn US government bond market (aside from the influx of pesky high-frequency trading firms). But an analyst at Bank of America Merrill Lynch has found more evidence that even mighty Treasuries have been affected by the liquidity crunch afflicting markets. Read more
Distracted as we were by liquidity events featuring quiz questions and former Federal Reserve chairmen, we missed this note from Citi earlier this week on the escalating effects of — one of our favourite subjects right now — petrodollar liquidity removal from the oil producing sovereign complex.
From Citi (our emphasis):
One topic we have been focused on recently is the pressure coming from the withdrawal of liquidity by Middle Eastern entities. By funding source, 60% of the AUM in the SWF (Sovereign Wealth Fund) community comes from oil/gas economies. In the other 40%, there is also a great deal of commodity content. So, the acute terms-of-trade shock EM economies are now experiencing will probably continue to impact the ability of SWFs to support new investment flows in Emerging Markets bonds and stocks. According to our estimates the AUM at the top 10 SWFs in the world is now at USD 5.4 trillion. EM allocations, in many cases, are not properly disclosed, but the disclosed EM fixed income exposure at these funds is now running at 2.5-5.0% of AUM. That corresponds to USD 135-270bn, a sizeable portion of the current ~USD1 trillion worth of EM debt held by foreign investors.
Thanks to Matt Levine at Bloomberg, we all know “people are worried about bond market liquidity” — especially coming into a Federal Reserve rate-hiking cycle.
But did you know that people were also worried about bond market liquidity in the late 1930s? Read more
Do remember that, generally, many people are worried about people being worried about bond market liquidity.
This time we shall kick off with a very good note from Jim Croft at Standard Bank.
First, on why what’s changed is really just the cost of getting your trades done — which is going to anger those coddled folk used to abundant liquidity just being shoveled into their paths — with our emphasis:
In our world it’s the ability to swap a series of highly uncertain future cash flows for a payment two or three days later of hard cash. It’s a pretty cool service when you think about it (and not guaranteed by any bond prospectus that I have read.) But like any service that is provided, it has an associated price. So in my thinking what people really mean when liquidity has got “worse”, is that the price of liquidity has gone up. You can still get most trades done if you are willing to pay the new price.
Matt Levine in particular has been acting as collator of the collective angst for quite a while.
And the latest addition to that angst would suggest that (t)he(y) may well have a point:
That’s from Goldman’s Top of Mind, its regular outpouring on topic x. Where x = liquidity this time round. Read more
A truth from Barclay’s Jeffrey Meli…
When short-term assets are scarce, non-traditional alternatives emerge to meet the need…
A truth which should be read alongside Robin Wiggleworth’s latest summary of liquidity fear and the emergence of mutual funds and ETFs as its newest proof. Read more
A chart, from Deutsche, of the global pool of funds in 2014:
It’s from their annual Random Walk through the world’s financial markets. The top line: Read more
FT Alphaville has written before about how the pronounced collapse in the price of oil appears very reminiscent of the disintegration in the value of a certain subprime financial asset; both have been swift, disorderly and self-reinforcing.
A new report from The Bank for International Settlements emphasises the latter dynamic by drawing a connection between the vast sums of money energy companies have borrowed from investors in recent years as well as the retreat of traditional dealers from certain commodities-related transactions. The new dynamic has imparted a swift and sudden forcefulness to the recent price action in the crude price that goes beyond the effects of a simple change in production and consumption of oil. Read more
In one of our previous post about petrodollars, we cited BoAML on how nobody really knows how the petrodollar shadow liquidity flows through the global economy, apart from the fact that eventually they end up being repatriated to the US via investments in domestic stocks or bonds (both public and corporate).
It’s a point worth bearing in mind in the context of this working paper from the BIS’s Robert McCauley, Patrick McGuire and Vladyslav Sushko, from January, previously covered by Matt. Read more
Is that the calming fragrance of sanguinity? Perhaps. Lets return to the bond market and the state of answers to the question: what will happen if, when, maybe, interest rates go up instead of down.
The fear, simply put, is that at some point there will be an awful lot of sellers of bonds, and very few natural buyers. For the corporate bond market in particular, banks don’t hold as many bonds as they used to, and can’t take the sort of risks that buying big piles of bonds when everyone else is selling would imply.
If you are in a job, say manager of a bond mutual fund, where you have to give customers their money when they ask for it, this might make you nervous. If when maybe that day comes. Read more
As already mentioned, this may not be your usual oil-price decline. But it’s also not crude’s first appearance in the 50 per cent club:
Now, in absolute terms the falls aren’t comparable ($100 to $50 versus $30 to $15) but there are similarities. Read more
Yup. Analysts and economists still can’t decide whether the fall in oil prices is net positive or net negative for the global economy.
Unfortunately for the net positive camp, it looks increasingly like global demand and growth figures are beginning to side with the negativity team.
Indeed, the longer the oil price stays low, the more it looks like global stimulus hopes were overdone due to poor understanding of financial feedback loops in the commodity space.
So what’s behind the anomaly? How did a whole school of economists get this potentially so wrong? Read more
As we have already pointed out about Thursday’s unprecedented Swiss franc move following the SNB’s announcement about removing its 1.20 euro level floor and introducing a -0.75 per cent interest rate regime, the real story to pay attention to is what exactly motivated a price surge to that level.
Was it a), that the SNB simply under appreciated the scale of the undervaluation it had been engineering in the franc? Or was it b) that the SNB under appreciated just how thin FX market liquidity is in the market these days?
So as to not sit on the fence, we’re going to take a view and speculate that it’s actually all down to option two. Read more
For those who forgot to mark their calendars, January 1 marked the official start date of the Liquidity Coverage Ratio, which will be fully phased-in by 2019. The LCR aims to reduce bank vulnerability to runs by requiring lenders to hold a certain proportion of safe, easy-to-sell assets to offset their short-term obligations.
The easiest way for a bank to satisfy this requirement is to buy government debt and hold reserves with the monetary authority. In the US, domestically-chartered commercial banks hold about $600 billion in US Treasury debt — a shade less than 6 per cent of the total held by the public (excluding the Fed), as well as $1.5 trillion in cash and reserves at the Fed. Add in the $1.4 trillion of MBS guaranteed by Fannie and Freddie, which for regulatory purposes counts as a liability of the US Treasury, and you have roughly 28 per cent of the total value of domestically-chartered bank assets held in the form of safe and liquid securities. Read more
We’re trawling through the BoE’s 2007-2009 disclosures in search of geeky insights into what actually goes through the minds of central bankers on an operational level during a liquidity/banking crisis.
First up, from the 2007 batch, the BoE’s dilemma about how best to compensate for the liquidity it was dishing out to Northern Rock, when it didn’t have too much in the form of a gilt stash for use in wider open market operations.
This from the committee of non-executive directors meeting on November 15, 2007, (our emphasis): Read more
Fears are growing that the next crisis, if it should manifest, won’t come from any of the areas that spawned the 2008 crisis. To the contrary, it will emerge from areas we’ve not really had to worry about to date.
The key areas those in high places are now worrying about: the taken-for-granted presumed liquidity of the system.
This is an easy assumption for the asset management industry to make. For years investment banks have made a business of carrying liquidity risk on their balance sheets, mainly by internalising the inventory nobody else is prepared to hold. This sort of “we’ll buying anything just to make money from making markets” service as a result conditioned the buy-side to presume liquidity risk is something that just doesn’t really manifest anymore. Read more
Behold the current market liquidity debate as heard at a leveraged loan conference panel in New York today and illustrated with stick figures.* The debate rages outside the confines of the loan industry in the pages of Fortune, Euromoney and yes, the FT. Read more
Gary Jenkins at LNG sets out his views about what might happen to the corporate bond market once the Fed begins pulling back liquidity seriously.
It’s all down to the vanquished liquidity in the market already.
As he notes on Wednesday (our emphasis):
The concern at the present time is that as the Fed starts to remove the extraordinary stimulus that they have injected into the market interest rates will rise which will in turn lead to selling of corporate bonds. One theory is that the lack of liquidity in the corporate bond market will exacerbate the problem and thus prices will move very sharply downward as a host of sellers are met by very little appetite for risk by the natural providers of liquidity, the investment banks.
There is little doubt that day to day liquidity in the corporate bond market has reduced substantially since the Great Financial Crisis. Risk appetite has reduced and regulatory changes have also had an impact. A chart that sums this up very well was produced by the credit strategy team at Deutsche. I reproduce it below:
RBS have joined the chorus of concerns about dangers in credit markets from thin trading volumes and a lack of risk takers making markets.
The bank also, it turns out, has a measure for trading lubricacity:
Our Liquid-o-Meter shows liquidity in the credit markets has declined around 70% since the crisis, and it is still falling. We define liquidity as a combination of market depth, trading volumes and transaction costs: all have worsened. We also measure the premium for illiquidity: it is at a record low, meaning investors are not getting paid to take liquidity risk.
Tracy Alloway hosted a session on the “death of a financial intermediary” at last week’s Camp Alphaville.
The discussion featured Renaud Laplanche, CEO of Lending Club, Cormac Leech, bank analyst at Liberum Capital, Krishan Rattan, founder of Voltaire Capital and Matt Levine, Bloomberg View columnist.
More on the topic of liquidity, which we’re choosing to understand as the ability to buy or sell when you want to without paying a lot for the privilege. Markets composed of rational, or at least reasonably calm, buyers and sellers. That sort of thing.
From San Francisco comes a video of JP Morgan’s Jan Loeys, shot in the straight-to-camera style of a 1970s news bulletin which lends the whole thing a certain gravitas. The message is to think about liquidity, and to prepare for its possible absence. Read more
Earlier this month South Korea sold $1bn of US dollar denominated debt due in June, 2044.
Issued at a spread of 72.5 basis points over a 30-year Treasury, eager buyers have since pushed the spread down to just 46 basis points. Such is the demand for income in any form.
Some might wonder if there will be periods in the 2020s, or 2030s even, when the owner of such a bond might wish they had bought, for only half a percentage point less, securities which trade in a market of far greater depth. Read more
The chart above from a Credit Suisse note, showing that trading assets at the ten biggest US and European banks (measured by such assets) are now 17 per cent smaller than at their 2010 peak, shouldn’t come as a shock to anyone who followed the “FICC revenues suck” storyline from Q1 bank earnings season. Rates trading assets in particular have fallen precipitously in that time, by roughly a third, or $200bn.
But the strategists also provide an assessment of dealer balance sheet elasticity in a corporate bond selloff. Read more
Citi’s research team highlights the important point that Germany’s Bundesbank has signalled that it is open to an end to ECB sterilisation operations.
The move follows consecutive failures by the ECB to sterilise its bond purchases in the last month.
As the Citi analysts note, the failures potentially indicate funding pressures in the Eurozone, following the removal of a lot of excess liquidity from the system:
with the ECB failing to attract sufficient bids for its liquidity absorbing 7-day fixed-term deposit, sterilisation is not functioning as well as intended, with investors preferring to keep hold of some funds as the excess liquidity position dwindles. We suspect that the ECB could soon announce that it will suspend sterilisation at least until July 2015, during which period the ECB has committed to full allocation fixed rates for the 7-day MRO. Alternatively, the Governing Council could decide to lower/abolish minimum reserve requirements (last change from 2% to 1% in Dec-11) in order to tackle the recent increase in overnight interest rates that runs counter to its very accommodative monetary policy stance.
We first proposed the idea that QE could be (but wasn’t necessarily) deflationary a couple of years ago. It was dubbed a counter-intuitive idea by Tyler Cowen.
More recently, a similar proposition has been made by Stephen Williamson — though this time using models and proper math. His view is a little different to ours because it’s less focused on the safe asset squeeze and more on the conditions that generate a preference for cash over yielding paper in the first place. Hint: you have to think the purchasing power of cash will go up regardless. Read more
A while ago we speculated that because of the ongoing bifurcation of the eurozone market, Eonia rates could rise, and liquidity once again concentrate in core economies, as banks pay back their LTRO funds.
Even if it appeared that the system could handle the repayments, banks in core economies would still be inclined to take advantage of extremely cheap negative rates available in collateral markets, so as to earn a spread on the deposit facility in a way that arguably encumbered the remaining liquidity. That would make it less available to periphery institutions.
Meanwhile, without the additional layer of ECB liquidity in the system — which acts as a type of system-wide insurance mechanism — periphery banks would consequently be forced to make ever more competitive bids for Eonia funds, lifting rates across the board. Read more
With the S&P 500 making a fresh run higher at pixel time, it would be rude not to share the latest thoughts of Albert Edwards, Socgen’s Ice Age bear. Rather than gawping stocks, he reckons we should be mindful of the red metal…