Money markets have a tendency to be misunderstood.
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Sandy Chen at Cenkos has drawn our attention to an interesting development in the repo market: the Eurepo curve has inverted.
The financial industry task force assigned to reform part of the shadow banking system in the US is set to deliver final recommendations without fully resolving a key issue of concern for regulators, reports the FT. Failure to overhaul the so-called tri-party repo market could set big Wall Street groups on a collision course with financial authorities. The $1.7tn tri-party market is a big source of financing for banks. But their reliance on overnight funding from the system is believed to have played a role in the financial crisis. The Federal Reserve Bank of New York has threatened to force change if participants do not move voluntarily to reduce repo risk within a reasonable time. Bank of New York Mellon and JPMorgan are the biggest tri-party clearers.
Another interesting snippet from the BIS quarterly review regarding the role played in the recent funding crisis by the deteriorating operational capacity of broker dealers:
Traditionally, these have not been collateralised. Short-dated CDS premia increased sharply for US and European dealers in September and November (Graph 6, left-hand panel). The November increase came after the failure of MF Global highlighted the importance of sovereign risks. As their own funding conditions deteriorated, securities dealers tightened terms on securities financing and reduced their market-making activities. A Federal Reserve survey of 20 large securities dealers, published in October, already showed that financing asset-backed securities, corporate bonds and equities had recently become more expensive and required more collateral (Graph 6, centre panel). Read more
We’ve discussed why the ECB’s policy of applying different haircuts to eurozone government debt collateral may be adding to dysfunctions in the repo market.
It’s one reason why broadening the ECB’s list of accepted collateral to include lower-quality assets won’t make much of a difference on a policy scale. Read more
Dressing up a pig as a princess, doesn’t make the pig a princess, and concentrating all the counterparty risk in the financial system into one place, doesn’t make it vanish. It’s still there. For the most part.
Given that you haven’t done anything with the risk other than shift it, the logical conclusion is that regulators have to be ready to either backstop or wind-down a central counterparty (CCP) in order to prevent some potentially rather cataclysmic disruption to markets. Read more
Just when you thought it couldn’t get any worse… Jean-Claude Juncker, Luxembourg Prime Minister and president of the EuroGroup speaks:
Nov. 16 (Bloomberg) — Germany’s debt level is a “cause for concern,” Luxemburg Prime Minister Jean-Claude Juncker told the General-Anzeiger newspaper. “Germany has a higher debt than Spain,” Juncker was quoted as telling the Bonn-based newspaper in an interview to be published tomorrow. “The only thing is that no one here wants to know about that.” While Greece is on the right path to consolidate its budget, it’s not yet time to “see light at the end of the tunnel,” Juncker was cited as saying. If Greece were to leave the euro, it would create a “disastrous scenario,” he said. Read more
The Volcker rule, which bans US banks from trading for their own account, is set to include exemptions that some officials fear will weaken its impact, the FT says, citing people familiar with the situation. According to a 174-page draft of the rules seen by the Financial Times, and confirmed by people familiar with discussions between regulatory agencies, so-called “repo” transactions and securities lending, and near-term trading in currency and commodities – but not futures – will be permitted. The draft rules exempt from the prop trading ban “positions arising under certain repurchase and reverse repurchase agreements or securities lending transactions [and] bona fide liquidity management”. They also allow “positions in loans, spot foreign exchange or commodities”.
Hat tip to International Financing Review’s Christopher Whittall for directing us to this rather interesting article by Gareth Gore at IFR about the rise of collateral-swap type deals between European institutions and US investment banks, seemingly to plug the financing gap created by the departure of the US money market funds from Europe.
The following paragraphs are especially poignant, we think (our emphasis): Read more
We’ve just explained RBC Capital Markets’ thinking as to why cutting IOER might be worse than ineffective. That it could instead encourage systemic risk by increasing the incentive to fail to deliver securities for settlement, introduce an implicit tax on money (a.k.a negative interest rates) and worse still possibly encourage a deflationary spiral that would be hard to reverse.
Indeed, some analysts have told us that the SNB’s move to introduce a floor in euro/swiss rate was more about abandoning an extreme negative interest rate policy than anything else. Read more
By Jove! Someone’s finally got it.
Cutting interest on excess reserve is a hugely risky option for the Fed, and could do more damage than good (leading even to major systemic issues). We’ve said as much, and now RBC Capital markets makes the same argument too. But much more eloquently (dare we say). Read more
Bank of America Merril Lynch’s Shyam Rajan is one of our favourite repo market experts. He’s been following every twist and turn in this unique post-Lehman crisis repo environment.
And his view regarding the downgrade is clear. It will have little impact on the repo markets because most fund and index mandates will not change the way they treat US Treasury securities. They will, to all extent and purposes, remain invest-able. Read more
With the US debt ceiling debacle still in full play, anyone scouting for stress signals is very much tuned into developments in the US repo market.
Morgan Stanley’s US interest rate strategists have included a lovely set of charts in their latest research note that portray the moves in short-term markets due to the debt ceiling impasse. The strategists stress that the price moves don’t reflect liquidity shortages but are “the functional equivalent of a tightening, which is exactly what the economy does not need now.”
Quite. Click to expand the gory details. Read more
A deal required before an Asian markets drop on Monday. Bankers summoned to a joint meeting with officials in New York. Congress paralysed. Despite our continuing optimism and markets’ relative insouciance, it all sounds worryingly familiar.
Bloomberg reports on Friday morning that the Federal Reserve is preparing to issue guidance to banks should Congress fail to raise the debt ceiling and that the US treasury has invited all 20 primary dealers to a contingency briefing in New York. Read more
Money market funds continued to pull billions of dollars worth of cash out of the market on Thursday. Nomura says investors took $9bn a day out of money funds this week, while the Investment Company Institute says $62bn has left the funds in the past two weeks, the WSJ reports. Companies and big financial institutions are beginning to rethink their view that Treasury notes are indistinguishable from cash, NYT DealBook says. Between Monday and Wednesday investors pulled $17bn from funds that invested only in government securities, compared with daily inflows of $280m for much of July, Crane Data said. Yields were rising too in the repo markets, from about three basis points on Monday to 17 on Thursday night, according to Credit Suisse.
It may have escaped your attention but on Tuesday afternoon the Financial Stability Oversight Council (FSOC) published its first annual report into the state of the US financial system. Click below for 160 pages of pdf fun:
The debt ceiling cacophony largely silenced coverage of the report, which was mandated by the Dodd-Frank Act to highlight any emerging threats to
the American way of life the US economy. Read more
Wall Street bankers, from senior executives to traders, are complaining that the Federal Reserve is refusing to engage in scenario planning for a US downgrade or default, the FT says. With days until the Treasury’s August 2 deadline to raise the debt ceiling, bankers say they are not getting a response to efforts to discuss the market impact of a failure to reach a deal in Washington or if credit ratings agencies cut the US triple A rating. They want to address contingency planning for a run on money market funds that hold Treasury bonds, the impact on capital and liquidity ratios if there are large inflows or outflows of deposits and the potential effect on short-term financing from any problems in the repurchase, or “repo”, market.
US money market funds are stockpiling cash in case Congress fails to raise the debt ceiling, distorting the short-term market for US government debt and raising borrowing costs for banks and other financial institutions, the FT reports. While the funds will continue to hold US Treasuries in the event of a downgrade or default, they are building up liquidity and shunning certain securities due to fears that a failure to raise the debt ceiling could trigger client redemptions. Government-only money market funds have boosted the amount of cash available to meet redemptions within one week to 68 per cent of assets, from 48 per cent at the end of March, according to Barclays Capital. US banks are also bracing for a US default, by holding onto more cash and locking in longer-term financing, also in the FT. They are particularly concerned about the repo market, used for short-term funding.
After reversing their upward trajectory of late, MBS trade settlement fails in the US primary dealer repo market picked up rather forcefully last week. Read more
Barclays Capital’s latest collateral update continues to puzzle over why overnight general collateral (GC) is trading cheap to the overnight indexed swaps (OIS) — a.k.a. the effective Fed funds rate in the US.
Normally, the GC should fetch a lower rate than the unsecured rate. When it’s trading cheap, as above, it means the GC rate is higher than that of the unsecured equivalent. Read more
The European Repo Council put out an interesting paper earlier this month on developments in the repurchase and securities lending markets, post the Lehman and European sovereign crises. It’s available here.
Within it: views on the impact of short-selling bans, the problem of settlement failures as well the need for market infrastructure reform. Read more