The Fed rate-hike may have been priced in by the market, but what are the chances the market really priced in the effects of the rate-hike on the plumbing of the financial system, in particular with respect to the initiation of the unlimited RRP facility?
A report from Credit Suisse’ Global Rates Strategy team provides food for thought on Thursday.
For example, while we’ve already discussed the prospect of safe-asset starved MMF funds deploying en masse to the RRP facility, there’s an important nuance to be noted with respect to the winner funds and the loser funds in this new money-market paradigm.
From CS (our emphasis):
We expect that government-only money market funds are likely to see an inflow of $600bn-$1tn, while institutional prime funds could lose between $300-$500bn over the course of the year.
Distortions are occurring in collateralised funding and swap markets meaning secured funding is weirdly costlier than unsecured.
Bankers are blaming post-crisis leverage ratio regulation for the anomaly.
But what really does the aberration in the collateralised Fed-funds spread reflect?
Credit Suisse’s FI team puts it relatively simply this Thursday: it’s all about the cost of balance-sheet rental, which is now as scarce a commodity as oil: Read more
A strange thing is happening in money markets: the cost of borrowing unsecured wholesale funds is now below the cost of borrowing secured funds.
The problem, according to repo dealers, is that new leverage ratio rules are set to make it far too costly for repo market participants to transact.
Meanwhile in the world of swap spreads, as Bloomberg’s Tracy Alloway has been noting, rates have plummeted to historic negative lows which defy market logic. Read more
Banks have been pulling out of direct dealings in physical commodity markets ever since the Senate Report on Wall Street Bank involvement in the market outed a spree of systemic risks, competitive advantages and general concerns last November.
The question is, has this had any impact on commodity prices or even the ability of major commodity traders to get financing? Read more
Repo expert Scott Skyrm at Wedbush warned last week that August 24 could be a date to watch because it’s a GSIB surcharge calculation day, along with July 31 and September 30.
As he stressed:
Taking that one step further, traders are even thinking about September 30 quarter‐end Repo rates. And here’s another date to watch ‐ August 24th, which is the second G‐SIB capital surcharge calculation date (in addition to July 31 and September 30) We should expect some type of funding pressure and/or Repo market distortion on Monday. If there is no obvious change in GC rates, it could be that cash is permanently gone from the market through early October, or maybe even forever. With the GSE cash in the market this week and slight soft funding, it’s a good time to finance long positions through month‐end and into September.
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
No, this isn’t going to be another FT Alphaville post pontificating over what money is or isn’t. We’ve had plenty of that.
Instead, precisely because nobody can really agree on what money is or isn’t, we’re going to take the basic position that money is an amalgamation of many different things and totally subjective to the holder and acceptor.
Just that somehow, for the purposes of trade and, you know, peace and quiet, we in civil and ordered society carry on the pretence that money represents a common value set amongst us all, and therefore don’t mind when it’s treated in a fungible manner. Read more
“Money,” we were once told, “is whatever you can use to pay your debts.”
That definition is both precise and slippery, since much of what can be used as “money” during good times is prone to losing its money-ness precisely when the need to repay debt is greatest.
Think of someone in the days before deposit insurance trying to pull cash from a failed bank to cover expenses after losing a job — or, for a more recent example, a hedge fund attempting to cover redemptions from panicked investors only to find that the prime broker responsible for holding its cash had blown up and the collateral it had provided was worthless.
The only kinds of money that reliably hold their value are the ones explicitly backed by a strong government*. Unfortunately, there isn’t nearly enough available to satiate the total demand for cash. Financial firms fill the gap by creating products that often offer many of the conveniences of money but that lack government guarantees, thereby rendering them inherently unstable and prone to crises.
These products are “mostly money” in the way that Westley was only “mostly dead.” They were also the topic of the “Workshop on the Risks of Wholesale Funding,” which we attended last week at the Federal Reserve Bank of New York. Read more
The Fed’s 2008 transcripts offer an impressive insight into the state of the repo markets in 2008, not least the shortage of safe US assets, which it turns out was a key area of concern in Fed gatherings.
We’ll have more on some of the other repo elements, but in the meantime — given that we’ve raised the idea that China might be inclined to repo its UST stock with the Fed if it needs short-term dollar liquidity (or is possibly doing so already) — it’s worth noting the following exchange from the October 2008 transcript in which the committee wondered about the nature of collateral they should accept for emergency dollar swap lines with foreign central banks.
Rather than collateralising with their own currency the idea was raised that they should pledge their UST stock instead. Voila, an open precedent for sovereign-level repo arrangements with the Fed so as to ease the shortage of safe asset problem in the West whilst at the same time flooding dollar liquidity to foreign markets. Read more
According to the latest bi-annual European repo survey by ICMA, released on Wednesday, the market for repo in Europe shrunk to €5.5tn in December 2013 from €6tn in June 2013 — a sharp decline by any means.
As the ICMA press release notes: Read more
Since 2008, it’s somehow become conventional wisdom in regulatory and policy circles to deem shadow banking undesirable, risky or inherently unstable.
And yet, as SoberLook heroically alluded to on Wednesday, that may be a somewhat small-minded way to look at the phenomenon. Shadow banking is arguably as much an endogenous response mechanism to an under-banked area of the economy as it is a silo for risk and instability. In fact, if risk and instability end up concentrating in the shadow banking area it’s only because more conventional forms of banking have left those areas behind. Read more
We’ve been paying attention to the various ways in which oncoming regulations are likely to crunch parts of the shadow banking system.
After the Fed released its notice of proposed rulemaking for its implementation of the Liquidity Coverage Ratio last week, the Citi rates team noted that the matched-book repo market would be unaffected by the LCR but nonetheless should expect future regulations of a different kind. Read more
The prospect of a US technical default is unfortunately becoming an ever greater reality.
That said, there’s no reason to panic just yet.
If there is a D-day it isn’t until November 15.
What’s more, there’s an ever louder chorus of voices suggesting that a technical default may not matter at all.
How can that be? Read more
The FT’s Tracy Alloway and Michael Mackenzie report on Thursday that banks are making contingency plans to deal with the potential impact on the $5tn “repo market” of the US government missing a payment on its debt.
Which basically means determining when we should start treating a US Treasury Bill as a potentially defaulted security. Currently, you could say, the T-bill’s status exists in a quantum state. It could be the best collateral in the world, but then again it might not be. Which one it is depends entirely on an externality, and to some degree how we choose to observe it.
This is probably welcome news given that the role played by distressed collateral and repo markets back in 2008 is still poorly understood. Read more
This is a guest post by Manmohan Singh, a senior economist at the IMF. Views expressed are his own and not those of the IMF.
Some central banks (Fed, Bank of England) have become large repositories of good collateral as a result of their QE policies. But excess reserves at central banks are not the same thing as good collateral that circulates through the non-bank/bank nexus. Read more
The Italian government has not collapsed in a flurry of post-bunga bunga recrimination, at least not yet.
With the ECB standing ready, the debt markets are calm, and investors in the banks are feeling good about improvements in asset quality and the direction of earnings. Read more
Which part of future Fed tightening “is now completely up in the air”?
The answer (according to Societe Generale) is in the useful table below… click to enlarge: Read more
Imagine spending an entire career evaluating bad things that might happen to financial institutions. It’s no mere thought experiment done in passing, but rather a task that one slaves over in excruciating detail. For years upon years on a constantly moving chessboard of potential disaster.
So, who wants to be a regulator? Read more
Close adherents to Modigliani-Miller would likely respond to the whinging of banks, which are now peeved at the latest regulatory push for a supplemental leverage ratio, with a dismissive eye-roll and a sure, the banks always cry like bedwetting toddlers at having to raise more equity capital or to shed assets.
If the last three decades could be scrubbed away and the modern banking system weren’t an impenetrable thicket of old-school boringness and new-age shadow banking freak show, the M-M followers mostly would be right not to listen. Read more
We know the Chinese have a propensity to raise money against almost anything (commodities, trade receipts, export inventory, tech goods), but in Hong Kong the Wall Street Journal reported on Tuesday that some lenders are even willing to accept borrowers’ beloved handbags as collateral.
From the WSJ: Read more
Scott Skyrm noted on his blog earlier this week that it took only six months of Fed QE purchases to move GC rates from an average of 0.24 per cent in December 2012 to an average of 0.05 per cent this month.
There is, consequently, a growing distortion in the short-term funding markets, which is clearly one of the first unintended consequences of the QE programmes to surface: Read more
Earlier this month the Fed, together with the Office of the Comptroller of the Currency and the FDIC, proposed a leverage ratio rule for big US banks.
JP Morgan says it is now worried about the punitive effects such ratios might have on repo. Read more
An interesting point to ponder this weekend courtesy of Barclays’ Joseph Abate:
What is fed funds now measuring? Alternatively, there is a deeper question – does the fed funds rate accurately measure unsecured bank funding costs? After repeat rounds of asset purchases, bank reserves now exceed $2trn and all banks are massively long liquidity. No institution needs to borrow reserves in the market in order to satisfy its reserve requirements. So the only trades going through are originated from a handful of forced sellers who prefer to sell cash into the reserve market rather than leave it un-invested at the Federal Reserve for no return. And the volume of this activity is probably light as proportionally more of this cash is leaking into the repo market. Indeed, although there is no public information on the volume of daily fed funds transactions, based on several recent papers, we estimate that activity has shrunk from about $250bn/d before the financial crisis to probably less than $50bn/d currently. Read more
Tim Duy, professor of practice at the department of economics at the University of Oregon, is confusing Brad DeLong, professor of economics at Berkeley, with his observation that the Fed seems to be striving to change the mix but not the level of outright accommodation. This, at least, seems to be the motivation for taper talk.
We’re less confused, and quite like what Duy is saying.
Note the following (our emphasis): Read more
The working theme at FT Alphaville towers is that we’re in somewhat of a damned if we do taper/suspend QE, and damned if we keep going with it.
There is, as we’ve long been noting, good reason to suspect the economy cannot handle any more quantitative easing in its traditional form.
What’s more, we now know that even the whiff of tapering — which is anything but an unwind, as we’ve noted here – can cause undue chaos in risk assets. In which case, perhaps tapering isn’t as much of an option as many believe it to be.
After all, QE reflects the sovereign put. It’s the government subsidy which takes volatility away. If you stop dishing it out, there’s every chance bad things may happen.
And the following chart, which comes to us by way of Aurelija Augulyte, reflects this relationship perfectly: Read more
Courtesy of Bloomberg, a fine addition to FT Alphaville’s ongoing coverage of the “collateralise everything” trend:
Goldman Sachs Group Inc. (GS) accepted almost 15,000 bottles of fine wine as loan collateral from a former high-ranking executive, according to a regulatory filing last month. Andrew Cader, a former senior director at Goldman Sachs’s specialist-trading unit, pledged a secured interest in the wines, which are primarily from the Burgundy and Bordeaux regions of France, the filing showed. Read more
From ICAP’s Gilt Repo Comment on Monday:
The announcement by the DMO of further supply of UKT4T 15 (1.75 bln on the 29th May) is welcomed in light of the issue’s “tightness” in the REPO market. The bond overnight has averaged 11 bps through DBV to date in May and was tight in the 1st quarter. However, post Friday’s announcement the bond held its premium in term and it is not certain the additional supply will cheapen the issue despite the free float increasing.
1. Take as much collateral as possible and park it at the ECB.
2. Watch as market bifurcates around quality/inferior collateral.
3. Disregard spikes in settlement fails. Read more
Here’s an interesting thought. Could the gold sell-off be related to a squeeze on collateral brought on by a series of very different bank crises in Europe, starting with the SNS Reaal nationalisation and Anglo Irish emergency assistance operation and culminating with the Cyprus crisis?
It’s a theory being considered by Jeffrey Snider, chief investment strategist, at Alhambra Investment Partners.
The basic point being, when you haven’t got anything to repo and funding becomes tight, gold is likely to sell-off in anticipation of further banking and asset problems. Read more
In March we noted that the US Treasury had issued a request for information on who is holding large positions in the 2023 US Treasury note, following reports that the issue was experiencing repo difficulties. Not only was the issue trading in negative territory in the repo markets, there were reports of significant fails.
As ever with repo markets, information was scarce. Given the risk-on sentiment at the time, this seemed strange. Read more