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…
Liquidity and credit are not always best friends — Funding for Lending in the UK and the LTROs spring to mind. However, blaming liquidity alone for the lack of credit out there is obviously [expletives removed].
For one, banks can’t lend if they can’t find borrowers — although it might be unfair to blame borrowers who are seeing unappealing terms — and for two, central banks have poured a fair amount of liquidity out there with more available on tap.
Barclays views it as imperative that the market has access to Benchmarks that are well constructed, transparent and that inspire the confidence of other market participants and regulators…
You can say that again.
Some (more) Libor reading landed this week — the responses from banks, and other cogs and gears of the market, to a recent report by Iosco about reforming financial benchmarks. Everyone from Thomson Reuters to the European Central Bank, Blackrock to Calpers, has weighed in here. Read more
Forget about the $1 trillion coin debate.
The most exciting wonky discussion being had right now is between Steve Randy Waldman and Paul Krugman over whether “base money” and short-term debt are perfectly substitutable or not, and what that may or may not mean for central bank policy.
We confess that we have a bit of a vested interest here because for a long time we’ve been arguing much the same point as Waldman.
That’s not to say that Krugman is necessarily wrong; he may just be taking Waldman slightly too literally. Read more
We’re still getting over Mervyn King saying the following when announcing changes to the liquidity coverage ratio, as Kate reported on Monday (emphasis ours):
Since we attach great importance to try to make sure that banks can indeed finance a recovery, it does not make sense to impose a requirement on banks that might damage the recovery…
The Basel Committee on Banking Supervision has finalised rules for bank liquidity. Some of the changes had been anticipated in recent weeks, particularly after the US banks ramped up their lobbying efforts. That said, they’re still quite a big departure from the 2010 draft rules, especially on what qualifies as a high quality liquid asset.
The complete set of changes is on the BIS website, but here are some highlights. Read more
Quite the rally in T-bills… continuing apace on Friday, now that the Transaction Account Guarantee has become increasingly, quietly, talked about in the past tense ahead of a year-end renewal deadline.
(Chart of the 1-year T-bill, click to enlarge. The yield on a T-bill maturing in January was close to zero at pixel time) Read more
What matters to an investor when they are choosing assets to invest in? Risk-return is the most obvious trade-off to balance. One can narrow down by asset class and sector, dividing up to achieve diversity (or an illusion thereof).
The memory of the latest crisis still being as fresh as it is, many investors are focused on the liquidity component that sits under the broader category of risk. How fast, and how efficiently, can an asset be cashed in? Read more
The People’s Bank of China helped Asian stocks rally on Tuesday with a reported record liquidity injection via reverse repos. From Bloomberg:
The People’s Bank of China conducted 220 billion yuan ($34.6 billion) of reverse-repurchase operations, the most in a single day, according to a trader at a primary dealer required to bid at the auctions. The government may introduce new policies to boost consumers’ borrowing and spending this year, the Economic Information Daily reported today, citing an unidentified person. Read more
Banks are lending neither to each other, nor to the real economy, in the way they used to. In Europe in particular, loan growth remains subdued. In the UK, there’s a lot of hope riding on the Funding for Lending Scheme to alleviate the situation.
While some of the great deleveraging is a question of reining in past excesses and lax standards, another part of it is regulation-driven. We have no less an authority for that than Mario Draghi, president of the European Central Bank — in the less-remarked bits of last month’s London speech: Read more
We wade into choppy waters here. But, we couldn’t help ourselves…
Karl Whelan, expert on all matters Target2 and arch nemesis of Hans-Werner Sinn, has encapsulated his views on Target2 a.k.a “why Hans-Werner Sinn is so very wrong about everything” in a 37-page powerpoint presentation on Wednesday. Read more
From an engaging speech by Robert Jenkins — former F&C chairman, now a member of the Bank of England’s interim Financial Policy Committee — to the “trillion dollar generation” of hedgies at the Gaim conference in Monaco…
My third and final observation is that the days of instant market pricing and limitless liquidity may be fading. The “great moderation” conditioned many to underestimate credit risk. It also bred a generation of traders, money managers, bankers and risk officers to presume an unfettered flow of capital and instant access to narrow bid/offer spreads. Those of you who operate in less liquid instruments do not need reminding. You deal with it daily. Those of you who traded asset backed securities in 2008 can testify to the speed with which liquidity can disappear. Yet despite these examples, many continue to assume that at the currently liquid end of the trading security spectrum “liquidity” is free and will be freely available. Short term traders count on it; algo-trading depends on it. Long/short strategies presume you can short. Stop-loss disciplines demand you can cover – and cover quickly. Read more
Just when you thought no more could be written about collateral, shadow banking and repo, Manmohan Singh and Peter Stella come together to bring us a new paper on the core essence of money and collateral.
The story so far: the world has been plagued by a shortage of safe collateral and an over-dependence on shadow-bank funding, all of which has led to a breakdown in repo markets and secured funding, which is having more of an effect on financial markets than many first anticipated. Read more
We missed Willem Buiter’s comments on “additional credit claim” ECB collateral when they were published on Monday. But since it’s pretty strong stuff from the Citigroup economist…
(Might need a key. ELA = emergency liquidity assistance. GC = General Council. Rouble zone = background here; byword for monetary disintegration, basically.) Read more
Just as “free lunch” appears in a Bloomberg headline on the ECB’s three-year liquidity…
Here’s a pair of interesting analyst reactions to Friday’s details on eurozone central banks’ rules for accepting additional credit claims. It’s an expansion of eligible ECB collateral. But neither a free lunch – nor a source of easy carry – given the haircuts these assets (bank loans, from French real estate to Spanish public sector to Italian lease finance to Austrian SME, etc) will bear, it seems. Read more
Update — apologies for a rather disorganised (and long) post… but we’ve finally gained information from all seven eurozone central banks who’ll accept additional credit claims under the ECB’s new rules…
Lend to an Italian small business for five years, take the loan to the Bank of Italy for ECB three-year funding… get this kind of haircut: Read more
Greece is not printing its own money already. No drachmas are being issued by Greece, nor is there monetisation of public debt. However….
And with that rather tantalising intro — Stephane Deo of UBS blows the lid off something we’ve been wondering about Greece for a while. Read more