1 00:00:10,000 --> 00:00:13,240 Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast. 2 00:00:13,280 --> 00:00:19,240 Speaker 1: I'm Tracy Allaway and Joe. What's more volatile than cryptocurrencies 3 00:00:19,320 --> 00:00:25,560 Speaker 1: at the moment. I don't know if this is a 4 00:00:25,560 --> 00:00:27,720 Speaker 1: trick question, because I think there are a number of things, 5 00:00:27,960 --> 00:00:31,840 Speaker 1: but one thing that most people didn't expect up until 6 00:00:31,840 --> 00:00:35,040 Speaker 1: recently was bonds, US government bonds. I don't think they've 7 00:00:35,040 --> 00:00:38,559 Speaker 1: been it is volatile. Is cryptocurrencies? What they have been volatile? Now, 8 00:00:38,600 --> 00:00:41,519 Speaker 1: wait a second, there was a day where they actually 9 00:00:41,760 --> 00:00:45,120 Speaker 1: were more volatile than bitcoin at least, and I think 10 00:00:45,159 --> 00:00:48,160 Speaker 1: it was It was earlier this month after the Wall 11 00:00:48,159 --> 00:00:51,040 Speaker 1: Street Journal released that article saying that the FED might 12 00:00:51,240 --> 00:00:54,959 Speaker 1: hike rates by basis points right, and suddenly we had 13 00:00:55,000 --> 00:00:57,640 Speaker 1: this big move in bond yields and I think the 14 00:00:57,680 --> 00:01:00,880 Speaker 1: tenure U S Treasury the yield on jump something like 15 00:01:00,920 --> 00:01:03,960 Speaker 1: twenty eight basis points in a day, which was I know, 16 00:01:04,040 --> 00:01:08,160 Speaker 1: you love this a four standard deviation move and the 17 00:01:08,240 --> 00:01:10,720 Speaker 1: kind of thing that's only supposed to happen based on 18 00:01:10,800 --> 00:01:13,680 Speaker 1: normal distributions, Like once in a century have you ever 19 00:01:13,680 --> 00:01:17,360 Speaker 1: seen that tweet about this seemed to leave breaking through 20 00:01:17,400 --> 00:01:21,200 Speaker 1: the wall like the cool man? Have you? Like every 21 00:01:21,240 --> 00:01:25,679 Speaker 1: time someone says standard deviation, I'm not surprised. I'll find 22 00:01:25,680 --> 00:01:27,640 Speaker 1: it for you. Thank you. There's a really funny tweet 23 00:01:27,640 --> 00:01:29,760 Speaker 1: about it. Anyway, I will say that was a wild day. 24 00:01:29,760 --> 00:01:32,400 Speaker 1: I remember that Nick timorrose at the Washer journals and 25 00:01:32,480 --> 00:01:36,200 Speaker 1: they're gonna go instead of fifty and everyone believed them 26 00:01:36,560 --> 00:01:40,360 Speaker 1: and right, and it was just this huge instant repricing 27 00:01:40,400 --> 00:01:43,200 Speaker 1: of the entire curve, like really shocking, right, And so 28 00:01:43,319 --> 00:01:45,880 Speaker 1: a four standard deviation move, make of that what you will. 29 00:01:46,000 --> 00:01:49,040 Speaker 1: But bitcoins like move in the same period was something 30 00:01:49,080 --> 00:01:52,520 Speaker 1: like two point seven standard deviations. So we're talking about 31 00:01:52,760 --> 00:01:56,240 Speaker 1: the market for US treasury debt, which is one of 32 00:01:56,240 --> 00:01:59,880 Speaker 1: the most probably the most important market in the world. 33 00:02:00,200 --> 00:02:04,080 Speaker 1: It's basically the risk free asset against which all other 34 00:02:04,200 --> 00:02:06,960 Speaker 1: assets are judged, and it's supposed to be the most 35 00:02:07,040 --> 00:02:10,520 Speaker 1: liquid market in the world as well, And yet it's 36 00:02:10,600 --> 00:02:14,040 Speaker 1: having these big moves. And this isn't the first time, right, 37 00:02:14,080 --> 00:02:15,840 Speaker 1: you know, I said a move that's only supposed to 38 00:02:15,840 --> 00:02:18,639 Speaker 1: happen once in a century, But actually we see these 39 00:02:18,680 --> 00:02:21,440 Speaker 1: moves relatively often. And of course we had the big 40 00:02:21,480 --> 00:02:24,880 Speaker 1: blow up in yields in March. We had a big 41 00:02:25,000 --> 00:02:28,440 Speaker 1: rally in yields, and I think it was. We've had 42 00:02:28,600 --> 00:02:32,400 Speaker 1: numerous other high profile incidents where the market just seems 43 00:02:32,440 --> 00:02:36,560 Speaker 1: to like go nuts in extreme periods of alatility. We 44 00:02:36,639 --> 00:02:40,200 Speaker 1: do see this stress and it's it's not supposed to happen, right, Like, 45 00:02:40,240 --> 00:02:42,160 Speaker 1: that's the whole idea here, which is that there are 46 00:02:42,200 --> 00:02:44,880 Speaker 1: certain financial assets where yeah, it's supposed to happen, kind 47 00:02:44,919 --> 00:02:50,040 Speaker 1: of with treasuries because they're theoretically risk free, and because 48 00:02:50,160 --> 00:02:53,760 Speaker 1: say they can theoretically be you know, theoretically from an 49 00:02:53,760 --> 00:02:56,799 Speaker 1: economic standpoint, be like equivalent to reserves or almost like 50 00:02:56,840 --> 00:03:00,520 Speaker 1: cash at some point, the ultimate safe haven asset, uh asset. 51 00:03:01,160 --> 00:03:03,760 Speaker 1: They're supposed to just be that, like the one, the 52 00:03:03,840 --> 00:03:06,760 Speaker 1: one predictable thing, the son of the you know, the sun, 53 00:03:07,000 --> 00:03:11,240 Speaker 1: around which the financial universe revolves around, and everyone's in 54 00:03:11,240 --> 00:03:14,280 Speaker 1: a while, it doesn't happen, and that's not good. Yes, 55 00:03:14,480 --> 00:03:17,240 Speaker 1: not good is a good way of putting it. The 56 00:03:17,320 --> 00:03:19,640 Speaker 1: other thing that's happening at the moment is the FED 57 00:03:19,720 --> 00:03:22,920 Speaker 1: has started to unwind its massive balance sheet, right yeah. No, 58 00:03:23,080 --> 00:03:25,960 Speaker 1: So it's like I get another factor here, right, um, 59 00:03:26,000 --> 00:03:28,680 Speaker 1: And that actually happened. I think they started unwinding in 60 00:03:28,720 --> 00:03:30,919 Speaker 1: the same week where they raised interest rates by seventy 61 00:03:30,960 --> 00:03:33,320 Speaker 1: five basis points, so of course no one actually noticed 62 00:03:33,639 --> 00:03:36,840 Speaker 1: that this had started. But there's all these things going 63 00:03:36,880 --> 00:03:39,240 Speaker 1: on in the market. It seems like we keep getting 64 00:03:39,280 --> 00:03:41,440 Speaker 1: these dramatic events, so we really we need to dig 65 00:03:41,440 --> 00:03:43,240 Speaker 1: into it, don't we do it? All right, we do 66 00:03:43,320 --> 00:03:46,000 Speaker 1: actually have the perfect person to discuss. We are going 67 00:03:46,040 --> 00:03:48,760 Speaker 1: to be speaking with Josh Younger. He is currently a 68 00:03:48,800 --> 00:03:53,280 Speaker 1: managing director and Global head of Asset Liability Management, Research 69 00:03:53,320 --> 00:03:56,600 Speaker 1: and Strategy at JP Morgan. He was previously doing cell 70 00:03:56,720 --> 00:03:59,960 Speaker 1: side research at JPM, writing about interest rates and money market. 71 00:04:00,000 --> 00:04:02,120 Speaker 1: It's which I think was the last time we had 72 00:04:02,160 --> 00:04:04,400 Speaker 1: him on and I didn't know this, but he was 73 00:04:04,480 --> 00:04:09,400 Speaker 1: previously an astrophysicist, studying things like black holes and what 74 00:04:09,520 --> 00:04:12,760 Speaker 1: happens when large objects collide against each other. So maybe 75 00:04:12,800 --> 00:04:16,159 Speaker 1: the perfect analogy for the bond market. Perfect, all right, Josh, 76 00:04:16,240 --> 00:04:19,240 Speaker 1: thank you so much for coming on. All thoughts, Thanks 77 00:04:19,320 --> 00:04:21,000 Speaker 1: very much for having it. It's great to be back. 78 00:04:21,600 --> 00:04:25,359 Speaker 1: So maybe just as a as a beginning question, I 79 00:04:25,400 --> 00:04:29,080 Speaker 1: think people have probably heard that there may be liquidity 80 00:04:29,240 --> 00:04:32,000 Speaker 1: issues in the U S. Treasury market, or certainly there 81 00:04:32,000 --> 00:04:35,040 Speaker 1: are these bouts of volatility, but could you maybe give 82 00:04:35,080 --> 00:04:39,039 Speaker 1: us some color of what exactly we mean when we 83 00:04:39,120 --> 00:04:42,360 Speaker 1: talk about liquidity in the treasury market and what exactly 84 00:04:42,440 --> 00:04:45,280 Speaker 1: happens on a day like the one we saw recently 85 00:04:45,640 --> 00:04:49,080 Speaker 1: where ten year yields made this massive move. Yeah, so 86 00:04:49,600 --> 00:04:51,400 Speaker 1: I know it's it's always weird to see a four 87 00:04:51,440 --> 00:04:54,600 Speaker 1: standard deviation event, but if people were around, we had 88 00:04:54,600 --> 00:04:57,599 Speaker 1: a fifteen standard deviation event at least over a short 89 00:04:57,600 --> 00:05:00,080 Speaker 1: time scale. So, pulling in my old education, that's not 90 00:05:00,120 --> 00:05:03,000 Speaker 1: supposed to happen in the lifetime of the universe. So, uh, 91 00:05:03,160 --> 00:05:07,720 Speaker 1: standard deviations have their place. But you know, the normal assumption, 92 00:05:07,760 --> 00:05:10,920 Speaker 1: the Bell curve assumption, is not always necessarily the best one. 93 00:05:10,920 --> 00:05:13,520 Speaker 1: And for treasury markets in particular, you know what people 94 00:05:13,560 --> 00:05:15,160 Speaker 1: like to say that there are lots of fat tails, 95 00:05:15,240 --> 00:05:18,640 Speaker 1: like like unfrequent things happen at a much higher frequency 96 00:05:18,680 --> 00:05:21,160 Speaker 1: than you or otherwise expect. That's true of all financial markets. 97 00:05:21,000 --> 00:05:24,680 Speaker 1: It's definitely true bond markets. But the question when we 98 00:05:24,680 --> 00:05:27,720 Speaker 1: bring up liquidity is if we look at big changes 99 00:05:27,720 --> 00:05:31,680 Speaker 1: in price, is that because things have really changed, or 100 00:05:31,760 --> 00:05:35,440 Speaker 1: is it because there's some kind of market functioning or 101 00:05:35,720 --> 00:05:38,080 Speaker 1: other issue that is causing the price change to be 102 00:05:38,120 --> 00:05:42,839 Speaker 1: exacerbated for reasons other than fundamentals. So, uh, this is 103 00:05:42,839 --> 00:05:45,279 Speaker 1: a tough environment because you know the ft is actually 104 00:05:45,360 --> 00:05:48,240 Speaker 1: raising rates by seventy five basis points in a meeting, 105 00:05:48,360 --> 00:05:52,320 Speaker 1: So the outlook is truly changing rapidly, and so rapid 106 00:05:52,360 --> 00:05:55,960 Speaker 1: price changes would be expected just because you know the 107 00:05:56,200 --> 00:05:59,279 Speaker 1: fundamentals are shifting at the same pace. But we do 108 00:05:59,320 --> 00:06:03,000 Speaker 1: want to figure out out and watch if the market 109 00:06:03,040 --> 00:06:05,599 Speaker 1: is unable to transfer risk, because that's kind of what 110 00:06:05,600 --> 00:06:08,160 Speaker 1: the markets supposed to do. This was a lineup buyers 111 00:06:08,160 --> 00:06:11,080 Speaker 1: and sellers and take care of those bonds that don't 112 00:06:11,120 --> 00:06:13,560 Speaker 1: have an immediate buyer but have an immediate seller vice versa. 113 00:06:13,640 --> 00:06:17,800 Speaker 1: Like they're supposed to smooth out these fluctuations by by 114 00:06:17,960 --> 00:06:20,880 Speaker 1: having somebody in the middle. It's a market maker who's 115 00:06:20,920 --> 00:06:22,880 Speaker 1: the buyer to the sellers and the seller to the buyers, 116 00:06:22,920 --> 00:06:24,919 Speaker 1: and and can hold onto stuff that doesn't have an 117 00:06:24,920 --> 00:06:27,360 Speaker 1: immediate home. It's just basically running a store, right like 118 00:06:27,480 --> 00:06:30,120 Speaker 1: you're running a candy store. You've got inventory, you have 119 00:06:30,320 --> 00:06:33,080 Speaker 1: orders coming in, you've got customers coming in. You need 120 00:06:33,120 --> 00:06:35,040 Speaker 1: shell space, but you also need to make sure you 121 00:06:35,080 --> 00:06:37,120 Speaker 1: have enough customers to take out the inventory you're getting 122 00:06:37,160 --> 00:06:38,640 Speaker 1: in so you need to line all those things up, 123 00:06:38,640 --> 00:06:40,720 Speaker 1: and unfortunately, when you're a market maker, you can't really 124 00:06:40,760 --> 00:06:43,520 Speaker 1: control your inventory right that someone else's decision as opposed 125 00:06:43,520 --> 00:06:46,640 Speaker 1: to the candy store. But there are different ways to 126 00:06:46,640 --> 00:06:49,120 Speaker 1: to look at this um Usually we talked about the 127 00:06:49,160 --> 00:06:51,920 Speaker 1: depth of the market, which is if you look at 128 00:06:51,920 --> 00:06:55,080 Speaker 1: the screen. You're a trader on a desk and any 129 00:06:55,160 --> 00:06:59,280 Speaker 1: given dealer and you looked at the screen electronic markets 130 00:06:59,520 --> 00:07:02,360 Speaker 1: between dealers where they put up you know, I'm willing 131 00:07:02,360 --> 00:07:04,359 Speaker 1: to buy this much at this price or sell this 132 00:07:04,480 --> 00:07:07,360 Speaker 1: much at that price. How much size could you move 133 00:07:07,960 --> 00:07:09,960 Speaker 1: near the current price in the market. That's the market 134 00:07:09,960 --> 00:07:14,960 Speaker 1: depth that's really low. So that's immediately concerning because if 135 00:07:15,080 --> 00:07:17,120 Speaker 1: depth is low, that means if I go to sell 136 00:07:17,200 --> 00:07:20,240 Speaker 1: something that's bigger than the size on the screen, presumably 137 00:07:20,280 --> 00:07:22,160 Speaker 1: the price is going to change. And if that size 138 00:07:22,160 --> 00:07:24,640 Speaker 1: on the screen is really small, then an incrementally larger 139 00:07:24,680 --> 00:07:27,360 Speaker 1: trade still small in the grand scheme of things, is 140 00:07:27,360 --> 00:07:29,200 Speaker 1: going to move the price a lot. And the implication 141 00:07:29,360 --> 00:07:33,360 Speaker 1: is the market can't transfer risk without a big price impact. 142 00:07:33,920 --> 00:07:37,680 Speaker 1: So that's that's really important before moving on from that 143 00:07:38,360 --> 00:07:42,400 Speaker 1: on market depth. So okay, like Nick Timorrose comes out 144 00:07:42,440 --> 00:07:46,200 Speaker 1: and says they're gonna go. Of course you would expect 145 00:07:46,280 --> 00:07:48,760 Speaker 1: to see a big move because there is fundamental news. 146 00:07:48,840 --> 00:07:51,440 Speaker 1: There's a reason for the price of the curve to change. 147 00:07:51,440 --> 00:07:53,760 Speaker 1: Is markets digest the sort of new thing about the 148 00:07:53,800 --> 00:07:57,000 Speaker 1: fed trajectory. But as you say, it's like, okay, that's 149 00:07:57,000 --> 00:07:59,840 Speaker 1: gonna happen. How do you measure depth? What would be 150 00:08:00,000 --> 00:08:02,760 Speaker 1: sort of normal or healthy depth? Like, how would you 151 00:08:02,840 --> 00:08:06,360 Speaker 1: quantify that? And then what is the quantification of depth? 152 00:08:06,640 --> 00:08:09,880 Speaker 1: Right now? When the when the dealers look at their screen. 153 00:08:10,240 --> 00:08:13,440 Speaker 1: So we're data limited here because there's there's really two 154 00:08:13,600 --> 00:08:16,880 Speaker 1: kinds of markets that exist in something like a hubb 155 00:08:16,880 --> 00:08:20,320 Speaker 1: and spoke or a network. The first is the net 156 00:08:20,480 --> 00:08:23,680 Speaker 1: the the end users, right, so the holders of treasury bonds. 157 00:08:23,680 --> 00:08:25,080 Speaker 1: It could be a foreign central bank, it could be 158 00:08:25,080 --> 00:08:28,480 Speaker 1: an asset manager, a hedge fund. But the non dealer, 159 00:08:28,560 --> 00:08:32,360 Speaker 1: non bank end users of bond debt, so they just 160 00:08:32,400 --> 00:08:35,320 Speaker 1: hold it as an investment or a speculative asset. And 161 00:08:35,360 --> 00:08:38,120 Speaker 1: then and that market faces the dealers because when you 162 00:08:38,160 --> 00:08:39,960 Speaker 1: go to sell that bond or by another bond, you 163 00:08:40,000 --> 00:08:42,439 Speaker 1: call up your dealer, right, So there's there's an interface 164 00:08:42,480 --> 00:08:45,240 Speaker 1: there that is not particularly observed, but we don't really 165 00:08:45,240 --> 00:08:47,720 Speaker 1: know what's going on there. Usually people call that voice trading, 166 00:08:47,800 --> 00:08:50,800 Speaker 1: which is really like in the institutional market, I would 167 00:08:50,880 --> 00:08:53,400 Speaker 1: call up my dealer and say I need to sell 168 00:08:53,440 --> 00:08:56,400 Speaker 1: you a billion of tenure notes like big trades, big 169 00:08:56,440 --> 00:09:00,520 Speaker 1: institutional trades, and when retail gets smaller sizes, usually there's 170 00:09:00,559 --> 00:09:03,640 Speaker 1: some institution standing between them and the dealers, and then 171 00:09:03,679 --> 00:09:06,680 Speaker 1: there's the market between the dealers themselves. And in this 172 00:09:06,760 --> 00:09:08,800 Speaker 1: context dealer we'll talk about. I'm sure that the h 173 00:09:08,880 --> 00:09:11,880 Speaker 1: f T component of this the high frequency component, but 174 00:09:11,920 --> 00:09:15,720 Speaker 1: like the injured dealer, market is the way that dealers 175 00:09:15,720 --> 00:09:18,600 Speaker 1: pass frists around between each other, and in some sense 176 00:09:18,640 --> 00:09:21,040 Speaker 1: that's the more important market because if you think of 177 00:09:21,080 --> 00:09:23,319 Speaker 1: yourself as buying whatever someone is selling, and selling whatever 178 00:09:23,320 --> 00:09:25,079 Speaker 1: someone is buying, the amount of size you're willing to 179 00:09:25,120 --> 00:09:27,760 Speaker 1: show that the size trade you're willing to do is 180 00:09:27,800 --> 00:09:29,840 Speaker 1: informed by how easily and cheaply you can hedge that. 181 00:09:30,080 --> 00:09:32,320 Speaker 1: So the way I like to think about this, and 182 00:09:32,320 --> 00:09:34,280 Speaker 1: I'll get to your question in a second, the way 183 00:09:34,280 --> 00:09:35,920 Speaker 1: to think about this is you've got sort of risk 184 00:09:36,000 --> 00:09:38,680 Speaker 1: coming in from the outside, and users selling a bond, 185 00:09:38,720 --> 00:09:41,240 Speaker 1: for example, say they're selling a billion of those tenure notes, 186 00:09:41,800 --> 00:09:43,480 Speaker 1: They're going to call one or two dealers, not gonna 187 00:09:43,480 --> 00:09:45,960 Speaker 1: call everybody. Those one or two dealers are going to 188 00:09:46,000 --> 00:09:48,280 Speaker 1: buy that debt at some price, and they're gonna try 189 00:09:48,320 --> 00:09:50,839 Speaker 1: to hedge it. And what hedging really is is socializing 190 00:09:50,880 --> 00:09:55,400 Speaker 1: that slug of risk across the broader complex of dealers. 191 00:09:55,679 --> 00:09:57,120 Speaker 1: So they're all going to keep a piece of it, 192 00:09:57,559 --> 00:09:59,440 Speaker 1: but they're not going there. One dealer is not going 193 00:09:59,480 --> 00:10:02,040 Speaker 1: to hold the whole billion outright, there's too much risk 194 00:10:02,120 --> 00:10:04,520 Speaker 1: to hold as a market maker. Yields move a little bit, 195 00:10:04,880 --> 00:10:06,840 Speaker 1: all of a sudden, you've run through all of your capital, 196 00:10:06,840 --> 00:10:08,880 Speaker 1: and that's a problem. So the active hedging is the 197 00:10:08,920 --> 00:10:11,000 Speaker 1: act of taking pieces of that and spreading it around. 198 00:10:11,240 --> 00:10:13,920 Speaker 1: And that's what the inter dealer market does. That's the 199 00:10:13,960 --> 00:10:17,560 Speaker 1: electronic market that trades much more frequently. It's a decent 200 00:10:17,640 --> 00:10:21,520 Speaker 1: chunk of the overall volume traded, but it's almost entirely 201 00:10:21,559 --> 00:10:25,439 Speaker 1: concentrated in recently issued bonds. Broke a text by part 202 00:10:25,440 --> 00:10:28,480 Speaker 1: of the biggest venue for that UM. And that's where 203 00:10:28,520 --> 00:10:31,360 Speaker 1: we have good data because it's electronic, so we can 204 00:10:31,400 --> 00:10:33,720 Speaker 1: see the screens, so to speak, UM and we can 205 00:10:33,800 --> 00:10:36,240 Speaker 1: capture that data, and we can look at, say the 206 00:10:36,920 --> 00:10:41,120 Speaker 1: the total number of bids and offers within say two 207 00:10:41,120 --> 00:10:43,160 Speaker 1: to three levels of the best price. This is the 208 00:10:43,200 --> 00:10:46,320 Speaker 1: central limited order book. People call them CLOBs um, which 209 00:10:46,520 --> 00:10:48,920 Speaker 1: is always kind of a fun acronym, but they can 210 00:10:48,960 --> 00:10:53,200 Speaker 1: track that and say within three levels of the best price, 211 00:10:53,240 --> 00:10:56,120 Speaker 1: there is x million dollars on the screen to trade 212 00:10:56,240 --> 00:10:59,040 Speaker 1: on average during say the New York trading session. When 213 00:10:59,040 --> 00:11:00,760 Speaker 1: you do that, on average something like a hundred and 214 00:11:00,760 --> 00:11:03,280 Speaker 1: fifty million. Over long periods of time, for the past 215 00:11:03,280 --> 00:11:05,920 Speaker 1: ten years, that's averaged something like a hundred and fifty 216 00:11:06,040 --> 00:11:08,520 Speaker 1: two hundred millions, so that would be sort of typical 217 00:11:09,320 --> 00:11:12,760 Speaker 1: and bad times that can go down to five to 218 00:11:12,840 --> 00:11:16,000 Speaker 1: ten that's what we had in Now it's probably around 219 00:11:16,000 --> 00:11:18,559 Speaker 1: fourty or fifty million on average. Now this fluctuates a 220 00:11:18,600 --> 00:11:20,080 Speaker 1: lot over the course of the trading day, but this 221 00:11:20,160 --> 00:11:21,959 Speaker 1: is like if you were to close your eyes and 222 00:11:22,000 --> 00:11:23,800 Speaker 1: then you know, pick a time and look at it, 223 00:11:23,880 --> 00:11:26,760 Speaker 1: you get something like forty million to trade within three 224 00:11:27,280 --> 00:11:30,880 Speaker 1: levels of the best price. So that's low um. The 225 00:11:30,920 --> 00:11:33,600 Speaker 1: reason why that's important again is because that's that's the 226 00:11:33,840 --> 00:11:37,360 Speaker 1: liquidity available to the dealers themselves to hedge their risk, 227 00:11:37,400 --> 00:11:39,120 Speaker 1: and so if that number gets higher, they're willing to 228 00:11:39,120 --> 00:11:42,120 Speaker 1: make bigger markets facing clients. If that number gets smaller, 229 00:11:42,120 --> 00:11:44,800 Speaker 1: they're willing to get make smaller markets because they don't 230 00:11:44,800 --> 00:11:46,560 Speaker 1: have confidence that they can hedge out of the risk. 231 00:11:46,920 --> 00:11:51,360 Speaker 1: So that's low along the lines of different volatility episodes 232 00:11:51,400 --> 00:11:53,680 Speaker 1: we've seen in the past. So if this was August, 233 00:11:54,320 --> 00:11:56,560 Speaker 1: it would be probably a similar number. If this was 234 00:11:57,000 --> 00:12:00,640 Speaker 1: June or July the Taper tantrum, you get similar numbers 235 00:12:00,640 --> 00:12:04,160 Speaker 1: of that UM. March of twenty was much lower UM. 236 00:12:04,200 --> 00:12:07,719 Speaker 1: In November of two it was much lower UM. So 237 00:12:07,920 --> 00:12:10,520 Speaker 1: you know, it's been worse, but it's definitely not not 238 00:12:10,600 --> 00:12:29,800 Speaker 1: great out there. Can we talk a little bit about 239 00:12:29,880 --> 00:12:32,360 Speaker 1: March because I think that was when we first had 240 00:12:32,360 --> 00:12:35,600 Speaker 1: you on and we were talking about this big sell 241 00:12:35,679 --> 00:12:38,640 Speaker 1: off in the bond market, which was exactly what people 242 00:12:39,400 --> 00:12:42,360 Speaker 1: didn't expect to happen when we had a huge risk 243 00:12:42,400 --> 00:12:46,040 Speaker 1: off event which was the global pandemic and equities sliding 244 00:12:46,080 --> 00:12:49,640 Speaker 1: and all of that. What exactly is the consensus around 245 00:12:49,800 --> 00:12:54,720 Speaker 1: what happened in March of what was the issue that 246 00:12:54,720 --> 00:12:58,080 Speaker 1: that whole incident exposed. So it's funny, I think if 247 00:12:58,120 --> 00:12:59,800 Speaker 1: if memory stars I was supposed to talk about live 248 00:12:59,880 --> 00:13:02,480 Speaker 1: or form. We talked about and I think we eventually did, 249 00:13:02,520 --> 00:13:04,680 Speaker 1: like a few months later, but it like we did 250 00:13:04,760 --> 00:13:09,000 Speaker 1: ye more interesting events intervened. Yeah, so this brings up 251 00:13:09,040 --> 00:13:12,000 Speaker 1: a really important question, which is a liquidity versus market functioning, 252 00:13:12,520 --> 00:13:14,920 Speaker 1: Like what was so much worse back then? Because the 253 00:13:14,960 --> 00:13:17,320 Speaker 1: FED is unwinding their balance sheet, like you said, they're 254 00:13:17,320 --> 00:13:19,520 Speaker 1: not buying three trillion dollars worth of assets over a 255 00:13:19,520 --> 00:13:22,760 Speaker 1: few weeks were three trillion rather, so there's clearly a 256 00:13:22,800 --> 00:13:25,440 Speaker 1: lot less sense of urgency about the impact of this 257 00:13:25,520 --> 00:13:29,600 Speaker 1: illiquid episode versus the events of and And that's where 258 00:13:29,640 --> 00:13:31,360 Speaker 1: I think we should be very specific about what we 259 00:13:31,400 --> 00:13:36,320 Speaker 1: mean by liquidity, because what we really mean we're always 260 00:13:36,320 --> 00:13:38,760 Speaker 1: feeling around. This is the different people feeling different parts 261 00:13:38,760 --> 00:13:41,560 Speaker 1: of the elephant. But like once a trunk wins, one's 262 00:13:41,559 --> 00:13:43,400 Speaker 1: of one's a foot, but they don't really know the 263 00:13:43,440 --> 00:13:45,120 Speaker 1: whole picture. I think if we were to have the 264 00:13:45,200 --> 00:13:48,960 Speaker 1: full the full picture of the market, all the participants 265 00:13:49,480 --> 00:13:53,480 Speaker 1: and all of their risk tolerance and positioning, and we 266 00:13:53,520 --> 00:13:56,640 Speaker 1: would really be asking this question, can I sell when 267 00:13:56,640 --> 00:13:59,280 Speaker 1: there's more sellers and buyers? How much does it move 268 00:13:59,320 --> 00:14:03,760 Speaker 1: the price? Um and The implication there is can I 269 00:14:03,800 --> 00:14:07,120 Speaker 1: turn my treasuries into cash at a reasonable cost in 270 00:14:07,120 --> 00:14:09,960 Speaker 1: a reasonable period of time at scale. And that's not 271 00:14:10,080 --> 00:14:13,079 Speaker 1: just part of the fact that the treasury market is 272 00:14:13,080 --> 00:14:15,280 Speaker 1: perceived as risk free and is quite large. It's built 273 00:14:15,320 --> 00:14:18,679 Speaker 1: into a lot of the law. The the liquidity coverage 274 00:14:18,760 --> 00:14:21,640 Speaker 1: ratio does not distinguish between treasuries and cash. I'm not 275 00:14:21,680 --> 00:14:24,120 Speaker 1: a lawyer, but there's I believe a part of the 276 00:14:24,160 --> 00:14:25,760 Speaker 1: I R. S Code that says you can actually pay 277 00:14:25,760 --> 00:14:28,520 Speaker 1: your taxes in treasuries, which is the only financial asset 278 00:14:28,560 --> 00:14:32,360 Speaker 1: you can directly pay your taxes in. So like a 279 00:14:32,440 --> 00:14:34,480 Speaker 1: chart list would say, well then their money, right, And 280 00:14:34,520 --> 00:14:37,720 Speaker 1: so treasuries have special status and lots of different ways. 281 00:14:38,200 --> 00:14:40,880 Speaker 1: The reason they do is because it's supposed to be 282 00:14:41,200 --> 00:14:43,800 Speaker 1: as close to cash as any financial asset can be. 283 00:14:44,360 --> 00:14:46,040 Speaker 1: And that means I can move large size at low 284 00:14:46,080 --> 00:14:48,080 Speaker 1: cost because when you when you turn your bank account 285 00:14:48,080 --> 00:14:51,200 Speaker 1: into physical cash, they don't charge you a fee, right, 286 00:14:51,240 --> 00:14:54,160 Speaker 1: So so I need something that's convertible into into real currency. 287 00:14:54,640 --> 00:14:58,080 Speaker 1: The low cost and back in not only was depth low, 288 00:14:58,200 --> 00:15:00,040 Speaker 1: but the bid esque spread in the market was a 289 00:15:00,240 --> 00:15:02,240 Speaker 1: wide So what's going on now is the depth is low, 290 00:15:02,280 --> 00:15:04,680 Speaker 1: but if you're able to trade, you're able to trade 291 00:15:04,680 --> 00:15:06,600 Speaker 1: it roughly the biddest spread you were able to trade 292 00:15:06,600 --> 00:15:10,040 Speaker 1: out a year ago, especially in benchmark issues like the 293 00:15:10,040 --> 00:15:14,480 Speaker 1: tenure note back, it was three, four or five times wider. 294 00:15:14,720 --> 00:15:17,680 Speaker 1: So there were no bids or offers within three levels 295 00:15:17,720 --> 00:15:19,960 Speaker 1: of that market price. In fact, the market price if 296 00:15:19,960 --> 00:15:22,360 Speaker 1: you don't have bids or offers within one or two 297 00:15:22,440 --> 00:15:24,200 Speaker 1: ticks of the market price, then it's not really the 298 00:15:24,200 --> 00:15:26,360 Speaker 1: market price. We don't really know where the market price is. 299 00:15:26,480 --> 00:15:29,600 Speaker 1: And so back then market the market was not functioning, 300 00:15:29,640 --> 00:15:33,040 Speaker 1: it was not just a liquid and that's where the 301 00:15:33,160 --> 00:15:35,520 Speaker 1: urgency comes in. So the question is what's different now 302 00:15:35,640 --> 00:15:40,240 Speaker 1: versus ben What's going on now is a revision to expectations. 303 00:15:40,280 --> 00:15:44,000 Speaker 1: But more importantly, this is an environment that's served familiar 304 00:15:44,000 --> 00:15:46,680 Speaker 1: in certain respects. You know, we've had inflation before, not recently, 305 00:15:46,720 --> 00:15:48,680 Speaker 1: but we've had it before. We know what it is, 306 00:15:48,760 --> 00:15:51,160 Speaker 1: we know why the Fed is raising rates, We have 307 00:15:51,560 --> 00:15:54,560 Speaker 1: reasonable confidence around the range of potential outcomes. Will argue 308 00:15:54,560 --> 00:15:56,400 Speaker 1: about where the Fed is going to stop, but we 309 00:15:56,440 --> 00:15:58,760 Speaker 1: know they're going to keep raising rates until inflation comes down, 310 00:15:58,800 --> 00:16:00,960 Speaker 1: and we can say three four percent, five percent but 311 00:16:01,560 --> 00:16:05,120 Speaker 1: I don't think anyone's out there calling for fun trade. 312 00:16:05,160 --> 00:16:06,880 Speaker 1: So these are with thein the bounds of things we've 313 00:16:06,920 --> 00:16:10,320 Speaker 1: seen before. Back in it's so easy to forget just 314 00:16:10,480 --> 00:16:15,200 Speaker 1: how crazy the set of uncertainties was. And like, for example, 315 00:16:15,600 --> 00:16:17,720 Speaker 1: there was speculation they would just close the market for 316 00:16:17,760 --> 00:16:20,880 Speaker 1: some indeterminate period of time. Right, so if the markets closed, 317 00:16:20,920 --> 00:16:23,280 Speaker 1: the bidst spread is infinite because you can't transact, So 318 00:16:23,320 --> 00:16:25,640 Speaker 1: if you need cash, you need to get it now. 319 00:16:26,120 --> 00:16:28,440 Speaker 1: So like that creates a lot of urgency. So just 320 00:16:28,480 --> 00:16:32,440 Speaker 1: going back to March for a second, and as you 321 00:16:32,520 --> 00:16:37,080 Speaker 1: laid out nicely, like the law basically says treasuries are 322 00:16:37,160 --> 00:16:39,920 Speaker 1: cash or very close to cash or cash like and 323 00:16:39,920 --> 00:16:42,760 Speaker 1: should be treated as such. But if I recall, like 324 00:16:42,840 --> 00:16:46,200 Speaker 1: with Mar, part of the issue, and part of the 325 00:16:46,240 --> 00:16:48,920 Speaker 1: reason we saw these sort of extreme widening of the 326 00:16:48,960 --> 00:16:52,280 Speaker 1: spread is that even though there's theoretically free money on 327 00:16:52,360 --> 00:16:55,680 Speaker 1: the table for someone to come in and close these spreads, 328 00:16:55,720 --> 00:16:58,840 Speaker 1: that the demand for like pure cash was so strong 329 00:16:59,160 --> 00:17:03,280 Speaker 1: that nobody, no actors in any any part of the ecosystem, 330 00:17:03,280 --> 00:17:05,560 Speaker 1: whether it's edge funds or banks or whatever, wanted to 331 00:17:05,640 --> 00:17:09,280 Speaker 1: deploy capital, deploy balance sheet to close these spreads to 332 00:17:09,280 --> 00:17:12,639 Speaker 1: take advantage of these opportunities at scale. And so is 333 00:17:12,680 --> 00:17:14,800 Speaker 1: the problem or is there sort of like a core 334 00:17:14,880 --> 00:17:18,280 Speaker 1: problem with Yes, we want to treat treasuries is cash, 335 00:17:18,520 --> 00:17:20,439 Speaker 1: but the way we have the system set up is 336 00:17:20,480 --> 00:17:24,600 Speaker 1: such that we still depend on the risk taking appetite 337 00:17:24,640 --> 00:17:29,880 Speaker 1: of private investors to actually do that job in the end. Yeah, 338 00:17:29,920 --> 00:17:31,960 Speaker 1: so this gets to, you know, what are these dealers 339 00:17:31,960 --> 00:17:33,639 Speaker 1: actually doing? And I was I was referring to, you know, 340 00:17:33,720 --> 00:17:37,040 Speaker 1: matching buyers and salaries is one function, and holding inventories 341 00:17:37,080 --> 00:17:40,119 Speaker 1: the other. I'm gonna reference the SLR, the Supplementary Leverage Ratio, 342 00:17:40,119 --> 00:17:42,280 Speaker 1: because it's one example of a regulation that creates a 343 00:17:42,359 --> 00:17:44,920 Speaker 1: very different set of incentives for dealers that are has 344 00:17:45,040 --> 00:17:48,760 Speaker 1: within banks. And what the SLR does is it makes 345 00:17:48,800 --> 00:17:52,080 Speaker 1: all balance sheet count the same towards your capital requirements. 346 00:17:52,080 --> 00:17:55,320 Speaker 1: It makes balance sheet to scarce commodity. And that's not 347 00:17:55,359 --> 00:17:58,800 Speaker 1: necessarily a problem if it's not strictly binding, or or 348 00:17:58,840 --> 00:18:01,960 Speaker 1: there's relatively too a flow meaning as many buyers as sellers, 349 00:18:01,960 --> 00:18:04,840 Speaker 1: but in a one sided market where there's mostly sellers, 350 00:18:04,840 --> 00:18:06,760 Speaker 1: and that's what you're referring to, the most people want cash. 351 00:18:06,840 --> 00:18:10,240 Speaker 1: They don't want securities. It makes it very difficult for 352 00:18:11,359 --> 00:18:14,840 Speaker 1: a dealer that's housed within a bank to hold that 353 00:18:14,880 --> 00:18:18,320 Speaker 1: inventory because what what what balance sheet constraints do, what 354 00:18:18,440 --> 00:18:21,600 Speaker 1: leverage constraints do, is they turn that allocation of balance 355 00:18:21,600 --> 00:18:23,920 Speaker 1: sheet into a zero sum game. So when the treasury desk, 356 00:18:23,960 --> 00:18:26,359 Speaker 1: for example, wants to buy that billion dollars for the 357 00:18:26,359 --> 00:18:29,400 Speaker 1: tenure notes, and they are near their allocation limit. Because 358 00:18:29,400 --> 00:18:31,000 Speaker 1: if you want to limit the amount of balance sheet 359 00:18:31,000 --> 00:18:32,840 Speaker 1: of business uses, you just gave it everyone a limit 360 00:18:32,960 --> 00:18:35,120 Speaker 1: like that's a plausible way to do it. So that 361 00:18:35,119 --> 00:18:38,120 Speaker 1: that creates rigidities. And let's say they call up their manager, 362 00:18:38,119 --> 00:18:39,440 Speaker 1: and they call their manager and it goes all the 363 00:18:39,440 --> 00:18:40,920 Speaker 1: way up to chain. They say, I need another five 364 00:18:40,960 --> 00:18:43,960 Speaker 1: billion of balance sheet because there's so many sellers. And 365 00:18:44,000 --> 00:18:46,600 Speaker 1: I'm the treasury desk, I'm I'm I'm processing the most 366 00:18:46,800 --> 00:18:49,240 Speaker 1: important market in the world, right, so I need I 367 00:18:49,320 --> 00:18:52,359 Speaker 1: need that extra balance sheet. The reaction as well. So 368 00:18:52,440 --> 00:18:54,639 Speaker 1: does the prime business, so does the credit business, so 369 00:18:54,720 --> 00:18:57,919 Speaker 1: does the front end business, the short term credit desk, 370 00:18:58,040 --> 00:19:02,160 Speaker 1: so does the corporate lending business where you're drawing a revolvers. 371 00:19:02,160 --> 00:19:05,600 Speaker 1: So everyone's got their hand out, and that's a zero 372 00:19:05,600 --> 00:19:07,040 Speaker 1: sum game in the sense that like there is a 373 00:19:07,040 --> 00:19:09,399 Speaker 1: balancie allocation that the firm can use, and it it 374 00:19:09,440 --> 00:19:13,600 Speaker 1: makes it very hard in practice, especially at a high frequency, 375 00:19:13,600 --> 00:19:16,760 Speaker 1: like a high pace, things were moving quickly to get 376 00:19:16,800 --> 00:19:18,760 Speaker 1: those allocations where they need to be when they need 377 00:19:18,800 --> 00:19:21,480 Speaker 1: to be there. If you think back to that period 378 00:19:21,520 --> 00:19:24,680 Speaker 1: of time, it's easy with hindsight to say, well, you 379 00:19:24,720 --> 00:19:26,560 Speaker 1: know there wasn't that much selling, but you don't know that. 380 00:19:26,600 --> 00:19:28,639 Speaker 1: In the moment um. It's like driving a car three 381 00:19:28,680 --> 00:19:30,760 Speaker 1: hundred miles an hour towards a towards the wall with 382 00:19:30,760 --> 00:19:33,840 Speaker 1: your eyes closed and like it might work out, but 383 00:19:34,160 --> 00:19:37,280 Speaker 1: like it might not, and that creates a lot of hesitation. 384 00:19:37,400 --> 00:19:41,320 Speaker 1: So you have what's referred to as the dash for cash, 385 00:19:41,320 --> 00:19:47,160 Speaker 1: but it's really about a relative urgency to find liquid assets, 386 00:19:47,200 --> 00:19:51,240 Speaker 1: not securities, not long term securities, due to this concern 387 00:19:51,320 --> 00:19:53,359 Speaker 1: that one you might need that cash for something, and 388 00:19:53,400 --> 00:19:56,800 Speaker 1: too they might close the market tomorrow. That's the background. 389 00:19:56,840 --> 00:19:58,679 Speaker 1: I think the important thing to keep in mind as well, 390 00:19:58,680 --> 00:20:02,359 Speaker 1: and I think we talked about this back. There was 391 00:20:02,400 --> 00:20:06,280 Speaker 1: this push over several years to take those market making 392 00:20:06,320 --> 00:20:09,760 Speaker 1: functions and in parts, split them into two parts, and 393 00:20:09,800 --> 00:20:12,440 Speaker 1: push them out of the banking sector. Now this wasn't purposeful, 394 00:20:12,480 --> 00:20:14,479 Speaker 1: but that was the set of incentives ever created, so 395 00:20:14,520 --> 00:20:17,400 Speaker 1: that when you think about matching buyers and sellers, high 396 00:20:17,400 --> 00:20:20,239 Speaker 1: frequency traders took on a lot of that responsibility, and 397 00:20:20,280 --> 00:20:24,160 Speaker 1: they did that by doing very very high frequency, fast 398 00:20:24,240 --> 00:20:27,280 Speaker 1: arbitrage trades to try to spread the risk around really 399 00:20:27,359 --> 00:20:30,280 Speaker 1: quickly and go home with no inventory. So high frequency 400 00:20:30,280 --> 00:20:33,000 Speaker 1: traders generally don't have inventory at the end of the day, 401 00:20:33,000 --> 00:20:35,760 Speaker 1: so they're doing only matching like that's that's that's most 402 00:20:35,760 --> 00:20:39,680 Speaker 1: of their function and they were of that on screen depth, 403 00:20:39,960 --> 00:20:42,719 Speaker 1: so they were the majority of the market, but they 404 00:20:42,760 --> 00:20:45,640 Speaker 1: can't operate in a high volatility environment, so they tend 405 00:20:45,680 --> 00:20:47,879 Speaker 1: to The thing about h f T s it tends 406 00:20:47,880 --> 00:20:51,280 Speaker 1: to actually back away if something big is happening, right 407 00:20:51,320 --> 00:20:54,080 Speaker 1: like if there's a big data release, like often the 408 00:20:54,119 --> 00:20:56,879 Speaker 1: machines will kind of back away from making that market 409 00:20:57,000 --> 00:20:59,879 Speaker 1: until things settle down a bit. Yeah, like that at 410 00:20:59,880 --> 00:21:01,879 Speaker 1: the time, if you were to if you were to 411 00:21:01,920 --> 00:21:04,200 Speaker 1: look at the way the market trades in the three 412 00:21:04,200 --> 00:21:08,760 Speaker 1: seconds before the payrolls number drops on monthly Fridays, and 413 00:21:08,800 --> 00:21:11,639 Speaker 1: look at any day any period of that two weeks span, 414 00:21:12,000 --> 00:21:13,800 Speaker 1: and just how the market is trading like it felt 415 00:21:13,800 --> 00:21:17,800 Speaker 1: like payroll Friday at eight thirty all day long for 416 00:21:17,920 --> 00:21:19,840 Speaker 1: two weeks. And the reason is because if you're a 417 00:21:19,880 --> 00:21:22,000 Speaker 1: higher concentrator, you're trying to make those bit esque spreads. 418 00:21:22,040 --> 00:21:24,200 Speaker 1: You need to sell for a dollar and and and 419 00:21:24,359 --> 00:21:26,200 Speaker 1: buy it back for a little less and so like 420 00:21:26,320 --> 00:21:28,560 Speaker 1: if if market markets are moving around a lot, it's 421 00:21:28,600 --> 00:21:30,680 Speaker 1: really hard to monetize the spread. So there's a reason 422 00:21:30,760 --> 00:21:34,240 Speaker 1: for this, but in making it more complicated and costly 423 00:21:34,320 --> 00:21:37,159 Speaker 1: for bank dealers to perform that market making function. In 424 00:21:37,320 --> 00:21:40,320 Speaker 1: businesses like treasuries, the h f T s stepped in 425 00:21:40,359 --> 00:21:43,160 Speaker 1: to fill that need like a life finds away moment. 426 00:21:43,760 --> 00:21:45,919 Speaker 1: So they step and fill the fill the need. They 427 00:21:45,920 --> 00:21:47,879 Speaker 1: do a great job until things get dicey, and then 428 00:21:48,200 --> 00:21:50,359 Speaker 1: that business model does not operate well when vall is 429 00:21:50,440 --> 00:21:52,960 Speaker 1: very high, so they tended to jump and and and 430 00:21:53,119 --> 00:21:56,040 Speaker 1: drop the size they're willing to show. Can you talk 431 00:21:56,080 --> 00:21:59,440 Speaker 1: a little bit about the overall size of the treasury 432 00:21:59,520 --> 00:22:02,680 Speaker 1: market as well, because we have seen the US deficit growing. 433 00:22:03,119 --> 00:22:05,760 Speaker 1: I think the amount of treasuries outstanding is at something 434 00:22:05,840 --> 00:22:09,520 Speaker 1: like twenty three trillion dollars at the moment, and it's 435 00:22:09,560 --> 00:22:12,639 Speaker 1: gotten a lot larger in recent years. Even though the 436 00:22:12,760 --> 00:22:16,680 Speaker 1: FED has been purchasing US treasuries up until recently, how 437 00:22:16,720 --> 00:22:20,280 Speaker 1: does that impact ease of trading or the way the 438 00:22:20,359 --> 00:22:24,119 Speaker 1: market functions. Well, the FED helps a lot when they 439 00:22:24,160 --> 00:22:27,480 Speaker 1: buy half of the net supply for the past two years. 440 00:22:27,840 --> 00:22:29,840 Speaker 1: So there's been sort of two things going on there. 441 00:22:29,880 --> 00:22:33,320 Speaker 1: The first is the FED is really there too absorb 442 00:22:33,400 --> 00:22:36,840 Speaker 1: the supply, uh. And the second is the commercial banking sector, 443 00:22:37,600 --> 00:22:39,280 Speaker 1: which I believe is the sixth or seven of the 444 00:22:39,359 --> 00:22:41,120 Speaker 1: US commercial banking sector, which I think is the six 445 00:22:41,200 --> 00:22:43,760 Speaker 1: or seventh larger largest holder of treasuries, has been the 446 00:22:43,760 --> 00:22:46,840 Speaker 1: second largest buyer over the past two years. And that's 447 00:22:46,880 --> 00:22:49,000 Speaker 1: because when you grow the size of the banking system, 448 00:22:49,000 --> 00:22:52,119 Speaker 1: which is what KILLI quantitative easing does, there's this natural 449 00:22:52,200 --> 00:22:56,000 Speaker 1: need to find assets to support those new deposits. There's 450 00:22:56,040 --> 00:22:59,560 Speaker 1: new liabilities, and so banks have stepped into to absorb 451 00:22:59,600 --> 00:23:01,920 Speaker 1: a lot of supply, and there's a bunch of other 452 00:23:02,000 --> 00:23:04,760 Speaker 1: components in the market that that do sort of take 453 00:23:04,840 --> 00:23:08,200 Speaker 1: on a decent share of it. But the question is more, 454 00:23:09,240 --> 00:23:15,480 Speaker 1: is the market too big for the intermediation capacity offered? 455 00:23:15,960 --> 00:23:18,800 Speaker 1: I would argue that's probably still the case it's certainly grown, 456 00:23:18,920 --> 00:23:23,840 Speaker 1: if anything, and and bank appetites to market making treasuries 457 00:23:23,960 --> 00:23:28,280 Speaker 1: is not concreased. But that introduced vulnerabilities. So just because 458 00:23:28,320 --> 00:23:30,680 Speaker 1: that ratio is a little off doesn't mean the whole 459 00:23:30,720 --> 00:23:32,399 Speaker 1: world is going to fall apart at any moment. But 460 00:23:32,520 --> 00:23:34,840 Speaker 1: when the stress hits, which is what happened in twenty, 461 00:23:35,400 --> 00:23:39,440 Speaker 1: it really struggles to serve that function. And that sort 462 00:23:39,560 --> 00:23:42,439 Speaker 1: brings up the second thing that that non bank dealers 463 00:23:42,480 --> 00:23:44,240 Speaker 1: were doing, which is on the hedge front side. We 464 00:23:44,280 --> 00:23:47,119 Speaker 1: probably talked in at the time about basis trades and 465 00:23:47,880 --> 00:23:53,240 Speaker 1: and specifically holding securities levered with repo, so levered longs 466 00:23:53,400 --> 00:23:57,239 Speaker 1: in treasury securities that were hedged with futures positions. There 467 00:23:57,400 --> 00:24:00,359 Speaker 1: was a big position that built up over time. Cause 468 00:24:00,920 --> 00:24:02,879 Speaker 1: if balance sheet, again is a scarce commodity, it's a 469 00:24:02,920 --> 00:24:04,639 Speaker 1: zero sum game, then you have to sort of use 470 00:24:04,680 --> 00:24:07,320 Speaker 1: it or lose it as a client. And one way 471 00:24:07,400 --> 00:24:10,760 Speaker 1: to do that is to have positions that utilize a 472 00:24:10,800 --> 00:24:12,840 Speaker 1: repo line. You're sort of using your line of credit, 473 00:24:13,240 --> 00:24:15,560 Speaker 1: but you're hedging the risk in the futures market, and 474 00:24:15,600 --> 00:24:17,600 Speaker 1: so you're not actually taking any market risk, but you're 475 00:24:17,680 --> 00:24:21,480 Speaker 1: using your allocation, which looks a lot like holding inventory. 476 00:24:21,640 --> 00:24:23,240 Speaker 1: What dealers tend to do is they tend to be 477 00:24:23,359 --> 00:24:25,800 Speaker 1: long off the run securities off the run securities or 478 00:24:25,800 --> 00:24:27,560 Speaker 1: bonds that were issued a little while ago. They're not 479 00:24:27,640 --> 00:24:30,800 Speaker 1: the most recently issued security. That's what long term holders 480 00:24:30,840 --> 00:24:32,400 Speaker 1: tend to have, like stuff that was issued a while 481 00:24:32,400 --> 00:24:34,639 Speaker 1: ago when they sell it. Deals hold that inventory, and 482 00:24:34,680 --> 00:24:36,720 Speaker 1: they hedge in the futures market. On the hedge fund side, 483 00:24:36,800 --> 00:24:39,680 Speaker 1: there was a position that built up which was pretty passive, 484 00:24:40,200 --> 00:24:43,359 Speaker 1: mostly designed to use it rather than lose it on 485 00:24:43,480 --> 00:24:45,560 Speaker 1: balance sheet, and that looked a lot like inventory. And 486 00:24:45,640 --> 00:24:49,560 Speaker 1: so you have these two functions of matching trades performed 487 00:24:49,600 --> 00:24:52,320 Speaker 1: by h f t s and holding inventory performed by 488 00:24:52,359 --> 00:24:56,000 Speaker 1: hedge funds. That was a brittle arrangement because it was 489 00:24:56,000 --> 00:24:59,400 Speaker 1: basically taking the market making capacity and allocating it away 490 00:24:59,440 --> 00:25:03,320 Speaker 1: from banks to relatively unregulated institutions who are not subject 491 00:25:03,359 --> 00:25:06,359 Speaker 1: to the SLR, for example. And what happens in that 492 00:25:06,400 --> 00:25:09,920 Speaker 1: whole system comes crashing down because of a variety of 493 00:25:10,000 --> 00:25:14,240 Speaker 1: operational and market related concerns that basically make it untenable 494 00:25:14,359 --> 00:25:18,119 Speaker 1: to hold those basis positions and very difficult to operate 495 00:25:18,200 --> 00:25:22,120 Speaker 1: a high frequency trading operation. And so you have all 496 00:25:22,200 --> 00:25:25,679 Speaker 1: of this intermediation capacity that's in principle provided by non banks, 497 00:25:26,240 --> 00:25:29,920 Speaker 1: all of a sudden disappears, and if when the banks 498 00:25:29,960 --> 00:25:32,160 Speaker 1: are asked to take on the slack, they simply can't 499 00:25:32,160 --> 00:25:34,040 Speaker 1: do it for a reasonable price, which is why this 500 00:25:34,080 --> 00:25:35,960 Speaker 1: whole arrangement came to be in the first place, and 501 00:25:36,080 --> 00:25:39,119 Speaker 1: so the market stops functioning. Can I just ask, is 502 00:25:39,200 --> 00:25:42,040 Speaker 1: this sponsored repo? So this is just repo in general? 503 00:25:42,840 --> 00:25:45,440 Speaker 1: Some of it sponsored sponsored repo is definitely worth talking 504 00:25:45,480 --> 00:25:48,280 Speaker 1: about in terms of some of the solutions that are 505 00:25:48,520 --> 00:25:52,040 Speaker 1: proposed to this issue of intermediation capacity, But this is 506 00:25:52,119 --> 00:25:55,960 Speaker 1: just repo funded positions in general, sponsor and otherwise, Okay, 507 00:25:56,400 --> 00:25:59,160 Speaker 1: shall we talk a bit about sponsored repo in that case, 508 00:25:59,240 --> 00:26:03,119 Speaker 1: because this is talking about dealer's ability to intermediate the 509 00:26:03,200 --> 00:26:07,280 Speaker 1: market being perhaps too small or too constrained versus what's 510 00:26:07,280 --> 00:26:10,000 Speaker 1: going on there. And as you say, one of the 511 00:26:10,080 --> 00:26:13,480 Speaker 1: solutions to this issue has been the idea of sponsored repo, 512 00:26:14,000 --> 00:26:16,840 Speaker 1: which I think basically I wrote about this years ago, 513 00:26:17,000 --> 00:26:19,560 Speaker 1: so I can't remember everything, but I think it basically 514 00:26:19,720 --> 00:26:24,960 Speaker 1: allows banks to transact with counterparties like hedge funds without 515 00:26:25,080 --> 00:26:29,320 Speaker 1: necessarily bumping up against balance sheet constraints, and I think 516 00:26:29,400 --> 00:26:31,680 Speaker 1: they get it from the f d I C or no, sorry, 517 00:26:31,760 --> 00:26:34,760 Speaker 1: from the f I c C from Thick. Yeah. So 518 00:26:35,359 --> 00:26:37,840 Speaker 1: if the issue is balance sheet is a zero sum game, 519 00:26:38,600 --> 00:26:40,760 Speaker 1: then if you can increase the amount of balance sheet 520 00:26:40,760 --> 00:26:44,320 Speaker 1: that's being passed around the balantie capacity of banks, then 521 00:26:44,359 --> 00:26:46,400 Speaker 1: you've addressed the problem in part. So there's a couple 522 00:26:46,400 --> 00:26:47,720 Speaker 1: of ways to do that. The first is you can 523 00:26:47,800 --> 00:26:51,040 Speaker 1: just change the rules, right, and that's that's what the 524 00:26:51,280 --> 00:26:55,399 Speaker 1: Fed actually did on a temporary basis. They made a 525 00:26:55,440 --> 00:26:58,680 Speaker 1: temporary change to the supplementary leverage ratio that said, if 526 00:26:58,800 --> 00:27:02,080 Speaker 1: you're if it's or its treasury is on balance sheet, 527 00:27:02,080 --> 00:27:04,800 Speaker 1: which is an important distinction, but if the cash your treasuries, 528 00:27:05,000 --> 00:27:07,440 Speaker 1: it doesn't count anymore or for at least a year. 529 00:27:08,119 --> 00:27:10,280 Speaker 1: And the idea that was to create capacity, right because 530 00:27:10,320 --> 00:27:12,920 Speaker 1: now the size of my balance sheet I used for 531 00:27:13,040 --> 00:27:16,239 Speaker 1: that supplementary leverage ratio is just smaller, and certain things 532 00:27:16,320 --> 00:27:18,439 Speaker 1: don't contribute to that number, so I can do more 533 00:27:18,480 --> 00:27:20,400 Speaker 1: of them. In principle, that was the theory. That doesn't 534 00:27:20,440 --> 00:27:22,639 Speaker 1: necessarily work that way in practice, but you know, it's 535 00:27:22,680 --> 00:27:25,680 Speaker 1: a separate thing. So one way to do this is 536 00:27:25,760 --> 00:27:28,640 Speaker 1: to change the rules, change the game. The other way 537 00:27:28,720 --> 00:27:30,240 Speaker 1: you can do it is played a little differently, and 538 00:27:30,320 --> 00:27:33,800 Speaker 1: so you know, one thing that was proposed very quickly 539 00:27:33,880 --> 00:27:38,080 Speaker 1: after after the crisis in was to introduce a broad 540 00:27:38,200 --> 00:27:41,240 Speaker 1: clearing mandate for the treasury market. And the logic for 541 00:27:41,320 --> 00:27:45,000 Speaker 1: that was, on the one hand, it reduced settlement risk 542 00:27:46,000 --> 00:27:48,520 Speaker 1: by having all of these transactions go through a central counterparty, 543 00:27:48,880 --> 00:27:51,760 Speaker 1: so it will be less likely that securities, for example, 544 00:27:51,800 --> 00:27:53,760 Speaker 1: I could not be found in time, have less failures 545 00:27:53,800 --> 00:27:57,840 Speaker 1: to deliver, which in principle has an impact on uncertain 546 00:27:58,280 --> 00:28:01,240 Speaker 1: capital requirements and so forth. But you know, the more 547 00:28:01,320 --> 00:28:04,440 Speaker 1: interesting from my perspective, impact of that was that in 548 00:28:04,480 --> 00:28:06,919 Speaker 1: the repo market, if you were to clear all those trades, 549 00:28:07,480 --> 00:28:10,760 Speaker 1: the impact of central clearing is, say everyone's facing the 550 00:28:10,840 --> 00:28:15,280 Speaker 1: same counterparty. They're all facing fix, which is the clearing house. Um, 551 00:28:15,400 --> 00:28:17,440 Speaker 1: it's the same way it works in derivatives markets, where 552 00:28:17,880 --> 00:28:21,360 Speaker 1: everyone faces the CME because they're all there, all their 553 00:28:21,520 --> 00:28:25,680 Speaker 1: derivative exposures, all those contracts are novated or transferred to 554 00:28:25,760 --> 00:28:28,760 Speaker 1: a central counterparty that serves as the other side to 555 00:28:28,840 --> 00:28:31,520 Speaker 1: every trade, and so like they're naturally off setting because 556 00:28:31,520 --> 00:28:35,560 Speaker 1: every derivative markets are definitionally zero sum, and so they 557 00:28:35,600 --> 00:28:37,520 Speaker 1: have all the positions they can. They can match off 558 00:28:37,600 --> 00:28:41,200 Speaker 1: trades and reduce the overall through credit risk embedded in 559 00:28:41,240 --> 00:28:43,320 Speaker 1: derivative contracts. So in the in the treasury market, the 560 00:28:43,360 --> 00:28:47,720 Speaker 1: idea was, well, what if everybody just faced thick And 561 00:28:47,920 --> 00:28:49,920 Speaker 1: that has a couple of implications, but one of the 562 00:28:49,960 --> 00:28:53,320 Speaker 1: most important is that when they banks measure their balance sheet. 563 00:28:54,080 --> 00:28:56,800 Speaker 1: One of the ways they do that in repo markets, 564 00:28:56,800 --> 00:28:59,160 Speaker 1: as they say, am I facing the same counterparty? So 565 00:28:59,160 --> 00:29:01,680 Speaker 1: if you borrowed with the left and lent with the right, 566 00:29:02,280 --> 00:29:04,400 Speaker 1: you're kind of economically neutral. But if you do that 567 00:29:04,480 --> 00:29:07,800 Speaker 1: facing different counterparties, then they both contribute or one of 568 00:29:07,840 --> 00:29:10,360 Speaker 1: them contributes to to the leverage. And and that's because 569 00:29:10,360 --> 00:29:13,480 Speaker 1: those two trades can see each other in principle. But 570 00:29:13,560 --> 00:29:15,600 Speaker 1: if everyone's facing the same counterparty, then they can. And 571 00:29:15,680 --> 00:29:18,280 Speaker 1: so the idea there was, well, banks will get balance 572 00:29:18,280 --> 00:29:21,880 Speaker 1: sheet relief and elasticity, meaning they can grow their exposures 573 00:29:21,920 --> 00:29:25,240 Speaker 1: as needed because there'll be lots of offsets in the 574 00:29:25,280 --> 00:29:28,719 Speaker 1: way you measure leverage, and if you can count all 575 00:29:28,760 --> 00:29:33,120 Speaker 1: your economic offsets in your regulatory exposure, then that ratio 576 00:29:33,240 --> 00:29:35,360 Speaker 1: is less binding, which is like a lot of technical 577 00:29:35,400 --> 00:29:38,600 Speaker 1: ways to say, you know, a central counterparty will reduce 578 00:29:38,640 --> 00:29:40,200 Speaker 1: the amount of letg. You have to show from your 579 00:29:40,240 --> 00:29:59,240 Speaker 1: regulatory requirements. Why can't they just make those rules the 580 00:29:59,400 --> 00:30:03,000 Speaker 1: one year your rule where they said treasuries are equill cash, 581 00:30:03,160 --> 00:30:05,840 Speaker 1: why not just make that permanent, especially since other parts 582 00:30:05,920 --> 00:30:08,200 Speaker 1: of the law indicate that, and as you mentioned, like 583 00:30:08,280 --> 00:30:10,400 Speaker 1: you can pay your taxes with treasuries, So why not 584 00:30:10,640 --> 00:30:13,320 Speaker 1: just if so many parts of the law say treasuries 585 00:30:13,320 --> 00:30:15,480 Speaker 1: are cash, why not just have that be a permanent 586 00:30:15,560 --> 00:30:18,320 Speaker 1: part of bank regulations. Well, people have made that argument. 587 00:30:18,520 --> 00:30:21,440 Speaker 1: It's an ongoing debate as to other treasuries to be excluded. 588 00:30:21,440 --> 00:30:23,200 Speaker 1: It would be a little difficult in the context of 589 00:30:23,280 --> 00:30:26,400 Speaker 1: international standards to exclude treasuries and not be a little 590 00:30:26,480 --> 00:30:30,479 Speaker 1: out of out of the mainstream. But certainly cash at 591 00:30:30,520 --> 00:30:32,680 Speaker 1: the FED is one of those things that people argue 592 00:30:32,680 --> 00:30:34,360 Speaker 1: shouldn't be included. And one way to think about that 593 00:30:34,560 --> 00:30:36,400 Speaker 1: is if you get a lot of how might can 594 00:30:36,440 --> 00:30:38,800 Speaker 1: re line of credit right, and you take a hundred 595 00:30:38,840 --> 00:30:41,120 Speaker 1: thousand dollars out and you take that hundred thousand dollars 596 00:30:41,120 --> 00:30:43,600 Speaker 1: you put in the bank account and keep it there. 597 00:30:43,800 --> 00:30:46,080 Speaker 1: Don't do anything with it. So you always have cash 598 00:30:46,120 --> 00:30:47,400 Speaker 1: in the bank to pay down the loan, but you 599 00:30:47,440 --> 00:30:49,959 Speaker 1: still have the loan. Has your credit gone down? Are 600 00:30:50,000 --> 00:30:52,520 Speaker 1: you less credit worthy now as a consequence of doing that? 601 00:30:52,640 --> 00:30:55,240 Speaker 1: Because if you're if you're you want, if you have 602 00:30:55,240 --> 00:30:57,080 Speaker 1: a new liability and you have cash to back it, 603 00:30:57,840 --> 00:31:01,320 Speaker 1: you're you're sort of not really necessarily reducing your your 604 00:31:01,400 --> 00:31:04,080 Speaker 1: credit quality as a borrower, right, And so should you 605 00:31:04,120 --> 00:31:06,120 Speaker 1: have to hold more capital against that position is kind 606 00:31:06,160 --> 00:31:08,760 Speaker 1: of the lot the question, and and a lot of 607 00:31:08,840 --> 00:31:11,840 Speaker 1: jurisdictions or some jurisdictions have said, well, you shouldn't write 608 00:31:11,840 --> 00:31:13,640 Speaker 1: you are no longer, You're not less safe for sound 609 00:31:14,000 --> 00:31:17,400 Speaker 1: as a consequence of having more cash on the treasury side. 610 00:31:17,560 --> 00:31:19,800 Speaker 1: You know, people have argued, well that that has interest 611 00:31:19,880 --> 00:31:22,360 Speaker 1: rate risk associated with it. It's not purely fungible, it's 612 00:31:22,360 --> 00:31:25,200 Speaker 1: not purely cashless. Look what happened in you might have 613 00:31:25,240 --> 00:31:27,840 Speaker 1: a market functioning issue. But this is like an ongoing debate, 614 00:31:27,880 --> 00:31:31,280 Speaker 1: which is what's the proper measure of size for a bank? 615 00:31:31,640 --> 00:31:35,880 Speaker 1: Because the need to think about size constraints in general 616 00:31:36,040 --> 00:31:38,040 Speaker 1: is something that the Bossle Committee is very focused on 617 00:31:38,240 --> 00:31:40,680 Speaker 1: and and regulators are very focused on. After after the 618 00:31:40,720 --> 00:31:43,920 Speaker 1: two eight crisis. But you know how you measure that size, 619 00:31:43,960 --> 00:31:47,040 Speaker 1: what actually should contribute to that size measurement? How big 620 00:31:47,080 --> 00:31:49,680 Speaker 1: are you really and how risky are you really? Is 621 00:31:49,960 --> 00:31:54,720 Speaker 1: an ongoing source of debate. But the clearing question what 622 00:31:54,880 --> 00:31:57,400 Speaker 1: what's interesting there? I think And an important to note 623 00:31:57,480 --> 00:32:00,200 Speaker 1: is it's not a matter of direction, meaning you know, 624 00:32:00,600 --> 00:32:02,920 Speaker 1: if you were introduced to clearing mandate, the amount of 625 00:32:02,960 --> 00:32:06,840 Speaker 1: balantie allocated to tripo, like the amount of balanceie size 626 00:32:06,840 --> 00:32:09,600 Speaker 1: you'd show, would go down questions how much, And that's 627 00:32:09,600 --> 00:32:12,200 Speaker 1: where sponsored repo comes in, which is clearing is available 628 00:32:12,760 --> 00:32:15,240 Speaker 1: currently and there's a decent chunk of the market that's 629 00:32:15,240 --> 00:32:18,040 Speaker 1: actually cleared already, and so you know, it's not obvious 630 00:32:18,200 --> 00:32:20,480 Speaker 1: and and there's lots of ways, lots of reasons to 631 00:32:20,560 --> 00:32:25,800 Speaker 1: think that it would likely not meaningfully improve the leverage 632 00:32:25,880 --> 00:32:28,280 Speaker 1: constraints that banks are facing. That that is is a 633 00:32:29,240 --> 00:32:32,560 Speaker 1: very very mild self for what is otherwise a much 634 00:32:32,600 --> 00:32:36,080 Speaker 1: more acute problem. So we don't necessarily have a clearing 635 00:32:36,280 --> 00:32:39,840 Speaker 1: mandate in US treasury trading the way we do for derivatives, 636 00:32:39,880 --> 00:32:43,280 Speaker 1: where trades have to go through a central counterparty, but 637 00:32:44,320 --> 00:32:47,880 Speaker 1: we do have sort of some clearing going on in 638 00:32:48,000 --> 00:32:51,880 Speaker 1: the market through for instance, um if I SEC and 639 00:32:52,120 --> 00:32:57,480 Speaker 1: other ways, rather than just announce a total clearing mandate, 640 00:32:57,640 --> 00:33:01,840 Speaker 1: is there a way to incentivize market participants to do 641 00:33:02,080 --> 00:33:06,280 Speaker 1: more clearing voluntarily. Well, those incentives are there in the price. 642 00:33:06,600 --> 00:33:10,040 Speaker 1: So at times, for example, if you're a cash lender, 643 00:33:10,760 --> 00:33:13,760 Speaker 1: it's been advantageous to do that in a cleared format, 644 00:33:13,840 --> 00:33:15,960 Speaker 1: to do that via sponsored like banks will essentially pay 645 00:33:16,040 --> 00:33:18,480 Speaker 1: up a little bit to incentivize you to do that, 646 00:33:18,560 --> 00:33:20,320 Speaker 1: and the same is true on the borrower side. And 647 00:33:20,400 --> 00:33:25,040 Speaker 1: so like, this kind of balance sheet optimization work is 648 00:33:25,160 --> 00:33:28,320 Speaker 1: something that the larger institutions have gotten quite good at, 649 00:33:28,760 --> 00:33:32,600 Speaker 1: and they know how to price trades to sort of 650 00:33:32,760 --> 00:33:36,040 Speaker 1: push people or nudge them in the direction that benefits 651 00:33:36,080 --> 00:33:38,760 Speaker 1: their regulatory constraints, so that in that sense, like people 652 00:33:38,760 --> 00:33:42,400 Speaker 1: are acting economically, the issue is not so much you know, 653 00:33:42,640 --> 00:33:45,560 Speaker 1: can we push people in that direction? It's more you know, 654 00:33:45,680 --> 00:33:48,040 Speaker 1: what direction do they want to face? And by that 655 00:33:48,200 --> 00:33:51,400 Speaker 1: I mean when when rates are rising? Right for example, Now, 656 00:33:51,840 --> 00:33:54,320 Speaker 1: the way the hedge funds position for that is they 657 00:33:54,360 --> 00:33:56,719 Speaker 1: don't do repos which is a way to buy secure 658 00:33:56,840 --> 00:34:00,560 Speaker 1: by treasuries on using leverage. It's they do rostary buds, 659 00:34:00,560 --> 00:34:02,320 Speaker 1: which is you're going short the market, right, that's how 660 00:34:02,360 --> 00:34:06,960 Speaker 1: you position for rising rates, and so that creates netting inefficiencies, 661 00:34:06,960 --> 00:34:09,759 Speaker 1: which basically means you can't net off trades on the 662 00:34:10,239 --> 00:34:12,400 Speaker 1: on the borrower versus the lender side because there are 663 00:34:12,400 --> 00:34:14,840 Speaker 1: simply less borrowers out there. So you know, the the 664 00:34:14,880 --> 00:34:17,040 Speaker 1: amount of netting you can do in your book goes 665 00:34:17,160 --> 00:34:19,879 Speaker 1: down as a consequence of the positioning of the hedge 666 00:34:19,920 --> 00:34:23,160 Speaker 1: fund and speculative industry, those who are trying to short 667 00:34:23,200 --> 00:34:26,160 Speaker 1: treasuries and so in practice that actually makes a bigger 668 00:34:26,200 --> 00:34:30,680 Speaker 1: difference than the availability is sponsored trades. So it's not 669 00:34:30,760 --> 00:34:33,160 Speaker 1: about access to clearing as much as this is about 670 00:34:33,200 --> 00:34:35,000 Speaker 1: you know, do people think rates are going up or down? 671 00:34:35,280 --> 00:34:38,560 Speaker 1: Which is hothing you obviously can't control. Going back to 672 00:34:38,719 --> 00:34:43,319 Speaker 1: the present tense and you know, obviously March was an 673 00:34:43,360 --> 00:34:48,520 Speaker 1: extraordinary situation. I mean truly, Uh you know, maybe hopefully 674 00:34:48,840 --> 00:34:51,200 Speaker 1: once in a lifetime or once in a century, what 675 00:34:51,360 --> 00:34:55,360 Speaker 1: we've seen more recently should not be that rare. And 676 00:34:55,520 --> 00:34:57,880 Speaker 1: you know it's gonna happen multiple times probably in our 677 00:34:57,960 --> 00:35:01,520 Speaker 1: careers that people are surprised in a significant way by 678 00:35:01,960 --> 00:35:04,800 Speaker 1: the direction of the market. Because that's what markets do. 679 00:35:05,200 --> 00:35:07,919 Speaker 1: What are the lessons here and what you know, how 680 00:35:08,080 --> 00:35:10,160 Speaker 1: bad is it that you know, we saw we have 681 00:35:10,320 --> 00:35:12,680 Speaker 1: this lack of depth, that we have this gap between 682 00:35:12,719 --> 00:35:15,160 Speaker 1: treasuries that are you know, on the run versus off 683 00:35:15,160 --> 00:35:17,879 Speaker 1: the run treasuries and so forth, And is it something 684 00:35:18,000 --> 00:35:20,440 Speaker 1: that needs to be fixed? Is it something that you 685 00:35:20,480 --> 00:35:23,160 Speaker 1: know when you look at this lack of depth needs 686 00:35:23,239 --> 00:35:26,880 Speaker 1: some sort of like policy or architectural solution. Yeah, I 687 00:35:27,120 --> 00:35:30,520 Speaker 1: think the it's important not to oversolve for the problem. So, like, 688 00:35:30,600 --> 00:35:32,239 Speaker 1: as an example, if you have a plate and you 689 00:35:32,320 --> 00:35:34,759 Speaker 1: think it's cracked, and then you smash it on the 690 00:35:34,840 --> 00:35:38,560 Speaker 1: ground and it breaks along the crack, you've confirmed that 691 00:35:38,640 --> 00:35:40,799 Speaker 1: it was cracked, but that doesn't mean you should only 692 00:35:40,840 --> 00:35:44,080 Speaker 1: have plastic plates, right, So, like that's not the right 693 00:35:44,360 --> 00:35:47,160 Speaker 1: level of stress to solve for. And in a lot 694 00:35:47,200 --> 00:35:51,440 Speaker 1: of ways is the smashing of the plate and and 695 00:35:51,600 --> 00:35:54,239 Speaker 1: that it's usually going to break it. And that's because 696 00:35:54,320 --> 00:35:58,800 Speaker 1: it's extremely unusual. It is unique in lots of respects. 697 00:35:58,840 --> 00:36:00,920 Speaker 1: And yes, you could probably say that about any crisis, 698 00:36:01,040 --> 00:36:03,320 Speaker 1: but it's important to recognize that, like, we should not 699 00:36:03,400 --> 00:36:06,799 Speaker 1: be creating or designing a treasury market that is specifically 700 00:36:06,840 --> 00:36:11,040 Speaker 1: calibrated to survive a once in century pandemic liquidity squeeze. 701 00:36:11,520 --> 00:36:14,480 Speaker 1: That that is not the right level of of of 702 00:36:14,760 --> 00:36:17,719 Speaker 1: of rigor. And I think it's likely we can't do 703 00:36:17,880 --> 00:36:20,560 Speaker 1: that within reasonable constraints, Like there's a lot of reasons 704 00:36:20,640 --> 00:36:23,840 Speaker 1: to think that even in the absence of of leverage constraints, 705 00:36:23,880 --> 00:36:28,080 Speaker 1: even in the absence of of other issues, would have 706 00:36:28,120 --> 00:36:31,400 Speaker 1: been a mess in lots of ways regardless, So it's 707 00:36:31,480 --> 00:36:34,000 Speaker 1: unclear that we could actually have avoided that fate. The 708 00:36:34,640 --> 00:36:36,520 Speaker 1: but the question is do we want a more resilient 709 00:36:36,560 --> 00:36:38,640 Speaker 1: treasury market. I think they're The answer is very much yes. 710 00:36:39,400 --> 00:36:41,080 Speaker 1: It's important when we think about that if we go 711 00:36:41,200 --> 00:36:44,080 Speaker 1: through the list of reforms that have been proposed, to 712 00:36:44,360 --> 00:36:47,120 Speaker 1: think more in terms of like what is the what 713 00:36:47,280 --> 00:36:49,480 Speaker 1: is the quantitative impact, like how much is this going 714 00:36:49,520 --> 00:36:51,360 Speaker 1: to help? Not will it help? How much will it 715 00:36:51,440 --> 00:36:56,320 Speaker 1: help to reduce the fragilities in a system that that 716 00:36:56,560 --> 00:37:00,879 Speaker 1: under much less extreme circumstances, how has exhibited a lot 717 00:37:00,960 --> 00:37:04,120 Speaker 1: of a lot of frailty. And and that comes back 718 00:37:04,200 --> 00:37:11,680 Speaker 1: to this issue of disincentivizing banks from taking on high leverage, 719 00:37:11,719 --> 00:37:15,560 Speaker 1: low risk positions. Among those are RIPO and treasury intermediation 720 00:37:16,239 --> 00:37:18,520 Speaker 1: and to to say that there's a lot of reasons. 721 00:37:18,600 --> 00:37:20,680 Speaker 1: And this goes all the way back to the the 722 00:37:20,760 --> 00:37:23,719 Speaker 1: Fed Treasury cord in I teen fifties, where like the 723 00:37:24,360 --> 00:37:26,719 Speaker 1: proper function of the treasuring market is is a is 724 00:37:26,719 --> 00:37:29,800 Speaker 1: a matter of of national importance, like the the economy 725 00:37:30,160 --> 00:37:33,640 Speaker 1: requires it and so and it needs to be robust 726 00:37:33,760 --> 00:37:37,440 Speaker 1: to modest shocks or even significant ones. And so you know, 727 00:37:37,680 --> 00:37:41,360 Speaker 1: the question is when we, for example, include reserves in 728 00:37:41,480 --> 00:37:43,520 Speaker 1: the in the leverage rat show. And the reason why 729 00:37:43,520 --> 00:37:45,520 Speaker 1: I'm talking about cashing out treasuries is that you know, 730 00:37:45,640 --> 00:37:48,640 Speaker 1: capital is fungible, right, you have some capital requirement, and 731 00:37:48,680 --> 00:37:51,680 Speaker 1: if you create more space relative to minimums, if you 732 00:37:51,760 --> 00:37:55,160 Speaker 1: make sure the supplement or leverage ratio is really a 733 00:37:55,239 --> 00:37:59,040 Speaker 1: backstop rather than a binding constraint, then you have space 734 00:37:59,120 --> 00:38:01,560 Speaker 1: to do other activity that would otherwise consume balance sheet. 735 00:38:02,120 --> 00:38:04,680 Speaker 1: And and one of those treasury trading. You know, we 736 00:38:04,800 --> 00:38:07,000 Speaker 1: have to think about and and the Ft has been 737 00:38:07,040 --> 00:38:09,680 Speaker 1: quite clear that they are thinking about this. Whether now 738 00:38:09,719 --> 00:38:11,440 Speaker 1: the banking system is less safe and sound is a 739 00:38:11,480 --> 00:38:14,880 Speaker 1: consequence of a higher reserve balance, and whether that's the 740 00:38:15,000 --> 00:38:18,320 Speaker 1: right way to think about capital requirements and safety and 741 00:38:18,320 --> 00:38:20,960 Speaker 1: sound is. So that's on the regulatory side, and then 742 00:38:21,000 --> 00:38:22,920 Speaker 1: on the market structure side. You know, there are certain 743 00:38:23,600 --> 00:38:28,200 Speaker 1: ways in which you could reduce these procyclical tendencies. And 744 00:38:28,440 --> 00:38:31,680 Speaker 1: one of the things I like to highlight is cross margining. 745 00:38:31,719 --> 00:38:35,480 Speaker 1: It was cross margining in back in the ball was 746 00:38:35,680 --> 00:38:40,439 Speaker 1: very high and in those basis positions, the two legs 747 00:38:40,480 --> 00:38:43,200 Speaker 1: of the trade were margined separately. And by margin separately, 748 00:38:43,320 --> 00:38:45,959 Speaker 1: I mean that the tread the margin had to post 749 00:38:46,000 --> 00:38:48,719 Speaker 1: against the futures leg was based on an outright exposure. 750 00:38:49,120 --> 00:38:52,840 Speaker 1: The margin had to post against the cash leg. The 751 00:38:52,920 --> 00:38:55,360 Speaker 1: securities was an outright exposed based on raisin posed and 752 00:38:55,360 --> 00:38:57,440 Speaker 1: they couldn't see each other, so you could be sort 753 00:38:57,480 --> 00:38:59,320 Speaker 1: of well hedged, but still have to post margin on 754 00:38:59,400 --> 00:39:02,120 Speaker 1: both sides of your heads because those those two hedges 755 00:39:02,800 --> 00:39:06,319 Speaker 1: were margined independently. That sounds like a technical nuance. Why 756 00:39:06,360 --> 00:39:08,239 Speaker 1: am I talking about that in the context of like 757 00:39:08,400 --> 00:39:11,080 Speaker 1: changes to the overall structure the banking system. It's because 758 00:39:11,120 --> 00:39:15,000 Speaker 1: that creates post prosec locality back in and at that time, 759 00:39:15,360 --> 00:39:20,000 Speaker 1: the futures margins increased by several times very quickly, and 760 00:39:20,160 --> 00:39:23,160 Speaker 1: that naturally delivers the entire financial system, because if you 761 00:39:23,160 --> 00:39:25,719 Speaker 1: have to post more cash against a position, you get 762 00:39:25,800 --> 00:39:29,000 Speaker 1: less leverage. And you know that might be desirable under 763 00:39:29,080 --> 00:39:31,719 Speaker 1: normal times. I'm like, I say it's necessarily desirable. You 764 00:39:31,800 --> 00:39:33,560 Speaker 1: might want less leverage in the system, you might want more, 765 00:39:34,200 --> 00:39:36,920 Speaker 1: but reducing it rapidly during a period of stress is 766 00:39:37,120 --> 00:39:40,920 Speaker 1: sort of the factor problematic, both in in practical terms 767 00:39:40,960 --> 00:39:42,920 Speaker 1: because you gotta find that cash, but also like the 768 00:39:43,000 --> 00:39:45,719 Speaker 1: signaling value that it's it's important to keep in mind 769 00:39:46,520 --> 00:39:51,200 Speaker 1: if margins get tripled and no liquidations actually come as 770 00:39:51,200 --> 00:39:53,080 Speaker 1: a result of that, no one liquidates positions, they find 771 00:39:53,120 --> 00:39:55,880 Speaker 1: the cash elsewhere. You can still trade the market like 772 00:39:56,040 --> 00:39:58,279 Speaker 1: there might be liquidations, and and then it sort of 773 00:39:58,360 --> 00:40:00,399 Speaker 1: has the same impact. And you can you can see 774 00:40:00,440 --> 00:40:02,560 Speaker 1: that in part from the commodities experience in the past 775 00:40:02,600 --> 00:40:06,040 Speaker 1: few months, is there was this concern that margin requirements 776 00:40:06,080 --> 00:40:08,120 Speaker 1: were going to be We're going to force liquidations of 777 00:40:08,200 --> 00:40:11,120 Speaker 1: positions and and and that just creates a whole the 778 00:40:11,160 --> 00:40:13,680 Speaker 1: whole mess. So you know, one of the things you 779 00:40:13,760 --> 00:40:15,120 Speaker 1: can do is you can say, look, if you're well 780 00:40:15,200 --> 00:40:17,759 Speaker 1: hedged on an economic basis, you shouldn't have to post 781 00:40:17,760 --> 00:40:21,160 Speaker 1: as much margin. And that just reduces the pro cyclical 782 00:40:21,280 --> 00:40:24,919 Speaker 1: dynamic that the margin cycle introduces um and it makes 783 00:40:24,960 --> 00:40:30,080 Speaker 1: the market sort of more resilient to volatility shocks. You 784 00:40:30,239 --> 00:40:33,560 Speaker 1: mentioned how the FED is thinking about these issues, and 785 00:40:33,880 --> 00:40:37,120 Speaker 1: I think they published a couple of papers on this topic. 786 00:40:37,680 --> 00:40:43,160 Speaker 1: But why it doesn't the FED feel compelled to intervene 787 00:40:43,320 --> 00:40:47,160 Speaker 1: because clearly it's comfortable unwinding it's balance sheet. This is 788 00:40:47,200 --> 00:40:49,560 Speaker 1: just to play Devil's Advocate, by the way, but it's 789 00:40:49,760 --> 00:40:54,920 Speaker 1: comfortable unwinding it's balance sheet. It's comfortable, I don't want 790 00:40:54,960 --> 00:40:59,320 Speaker 1: to say abandoning forward guidance, but certainly surprising the market 791 00:40:59,560 --> 00:41:02,600 Speaker 1: as it recently. What do they see here that maybe 792 00:41:02,840 --> 00:41:06,880 Speaker 1: market participants don't or where does the difference in opinion 793 00:41:06,960 --> 00:41:08,840 Speaker 1: come from? Well, I think this comes back to the 794 00:41:08,920 --> 00:41:12,040 Speaker 1: question of is it a liquid or is it not functioning? 795 00:41:12,360 --> 00:41:16,600 Speaker 1: And this is where I think the the somewhat hyperventilating 796 00:41:16,640 --> 00:41:20,200 Speaker 1: language that traders often use is not terribly helpful. So, like, 797 00:41:20,719 --> 00:41:22,640 Speaker 1: the number of times anyone has been told their face 798 00:41:22,680 --> 00:41:24,480 Speaker 1: has been ripped off is like, probably not the right 799 00:41:24,560 --> 00:41:27,160 Speaker 1: number of times relative to how like intense that image is, 800 00:41:27,280 --> 00:41:30,400 Speaker 1: And so things are not I guess, And that's that 801 00:41:30,680 --> 00:41:35,600 Speaker 1: bad because transaction costs are manageable like if if risk 802 00:41:35,719 --> 00:41:37,680 Speaker 1: is is clearing, if you can get the trade done, 803 00:41:37,719 --> 00:41:40,359 Speaker 1: you can do it at relatively tight but offer at 804 00:41:40,400 --> 00:41:43,120 Speaker 1: least in the current issue that most recently issued bonds, 805 00:41:43,200 --> 00:41:46,000 Speaker 1: So like in that sense, the market is functioning. The 806 00:41:46,200 --> 00:41:50,160 Speaker 1: high freaksity traders have stayed involved much more so than 807 00:41:50,320 --> 00:41:53,760 Speaker 1: than prior volatility episodes. There have been some structural changes 808 00:41:53,800 --> 00:41:56,040 Speaker 1: to them, to the way these markets operate, and one 809 00:41:56,080 --> 00:41:59,279 Speaker 1: of the big advancements since has been the rise of 810 00:41:59,320 --> 00:42:02,840 Speaker 1: what what are are called bilateral streams or private central 811 00:42:02,880 --> 00:42:05,239 Speaker 1: limit order books, where you know, the issue with broker 812 00:42:05,280 --> 00:42:06,840 Speaker 1: techt is when you put it in order, everyone can 813 00:42:06,880 --> 00:42:08,440 Speaker 1: see it, even if they don't know who put it in. 814 00:42:08,560 --> 00:42:13,719 Speaker 1: Whereas these bilateral streams and private order books allow you 815 00:42:13,840 --> 00:42:16,359 Speaker 1: to string prices directly to specific clients so you don't 816 00:42:16,400 --> 00:42:18,360 Speaker 1: have to tip your hand in the same way. And 817 00:42:18,440 --> 00:42:20,520 Speaker 1: that that sounds like a small change, but it makes 818 00:42:21,280 --> 00:42:23,960 Speaker 1: it makes the showing of bigger size in general much easier, 819 00:42:24,040 --> 00:42:26,320 Speaker 1: so markets are more resilient. As consequence, that's become a 820 00:42:26,400 --> 00:42:30,120 Speaker 1: much more common way to trade inter dealer that then 821 00:42:30,239 --> 00:42:32,360 Speaker 1: was the case even a year ago. The question is 822 00:42:32,400 --> 00:42:34,480 Speaker 1: why are yields actually going up and is that bad 823 00:42:35,000 --> 00:42:38,279 Speaker 1: um And if you're the FED, you want to tighten 824 00:42:38,320 --> 00:42:42,280 Speaker 1: financial conditions presumably, so rising yields are not prima facial problem. 825 00:42:42,520 --> 00:42:44,399 Speaker 1: I feel like a dealer inventory is they're pretty low. 826 00:42:44,719 --> 00:42:46,960 Speaker 1: If you look at the way the RepA market is trading, 827 00:42:47,440 --> 00:42:50,960 Speaker 1: it suggests a scarcity of collateral. It's just's not enough 828 00:42:51,000 --> 00:42:53,560 Speaker 1: funds in the system rather than too many. What's probably 829 00:42:53,640 --> 00:42:57,799 Speaker 1: happening here is speculative investors are going short the market 830 00:42:57,840 --> 00:43:00,360 Speaker 1: in the way I describe through reverse repos more so 831 00:43:00,520 --> 00:43:03,960 Speaker 1: than real money, and users of securities of treasury bonds 832 00:43:04,360 --> 00:43:07,759 Speaker 1: were actually selling them, and so that's a lot less concerning, right, 833 00:43:07,800 --> 00:43:09,800 Speaker 1: So on the one hand, you're kind of getting the 834 00:43:10,320 --> 00:43:14,120 Speaker 1: macroeconomic outcome you want, and on the other you don't 835 00:43:14,239 --> 00:43:18,759 Speaker 1: have the outflows from from the real firm hands in 836 00:43:18,800 --> 00:43:21,480 Speaker 1: the market at the nearly the same scale you had 837 00:43:21,520 --> 00:43:23,759 Speaker 1: in twenties. So the need of the FED to take 838 00:43:23,840 --> 00:43:26,280 Speaker 1: those bonds out of the system is a lot less 839 00:43:27,080 --> 00:43:31,080 Speaker 1: because they're floating around in the levered complex anyways. It's 840 00:43:31,120 --> 00:43:33,640 Speaker 1: not like you have long term holders looking to liquidate 841 00:43:33,719 --> 00:43:35,320 Speaker 1: and no one on the other side. You take it 842 00:43:35,400 --> 00:43:37,360 Speaker 1: all together and like, what what if I was at 843 00:43:37,400 --> 00:43:39,719 Speaker 1: the FED way to be concerned. Absolutely, you know, low 844 00:43:39,840 --> 00:43:43,040 Speaker 1: levels of depth, high levels of all, a very uncertain 845 00:43:43,120 --> 00:43:47,200 Speaker 1: macroeconomic environment and policy environment are all reasons for concern. 846 00:43:48,080 --> 00:43:51,440 Speaker 1: But would I'd be convinced that not only are markets 847 00:43:51,600 --> 00:43:54,320 Speaker 1: functioning poorly, but that they are not functioning to the 848 00:43:54,360 --> 00:43:57,200 Speaker 1: point where this could create other contagion effects in the 849 00:43:57,239 --> 00:44:01,080 Speaker 1: financial system and necessitates basically sucking the Venomo out, which 850 00:44:01,120 --> 00:44:04,520 Speaker 1: is what those market functioning purchases were. We're definitely not there. 851 00:44:04,600 --> 00:44:07,000 Speaker 1: I mean, we're we're very far away from that kind 852 00:44:07,040 --> 00:44:09,279 Speaker 1: of thing, so, you know, in that sense, it's a 853 00:44:09,360 --> 00:44:12,880 Speaker 1: familiar kind of stress, which is still no fun, but 854 00:44:13,000 --> 00:44:16,640 Speaker 1: it is not the kind of existential angst created by 855 00:44:17,440 --> 00:44:21,200 Speaker 1: by the environment of existential angst. That's a good way 856 00:44:21,280 --> 00:44:23,480 Speaker 1: of describing it. Josh, We're going to have to leave 857 00:44:23,520 --> 00:44:24,840 Speaker 1: it there. I feel like we could talk to you 858 00:44:24,960 --> 00:44:28,000 Speaker 1: for another hour on this topic. But thank you so 859 00:44:28,120 --> 00:44:31,000 Speaker 1: much for coming on all thoughts. That was great, that 860 00:44:31,120 --> 00:44:50,200 Speaker 1: was great feedback. Thanks for having yea. Thanks John so Joe. 861 00:44:50,280 --> 00:44:52,640 Speaker 1: I feel like existential angst is a really good way 862 00:44:52,680 --> 00:44:55,600 Speaker 1: of putting the experience of and that's when we did 863 00:44:55,719 --> 00:45:01,120 Speaker 1: see some momentum towards actually addressing of problems that Josh's 864 00:45:01,120 --> 00:45:03,960 Speaker 1: outlining in the world's most important market. But it does 865 00:45:04,080 --> 00:45:09,000 Speaker 1: feel like, absent a major crisis, these issues just kind 866 00:45:09,040 --> 00:45:11,920 Speaker 1: of like limp along. Yeah, I think that's right. And 867 00:45:12,120 --> 00:45:14,239 Speaker 1: you know, it's not some of this stuff. It's not 868 00:45:14,520 --> 00:45:16,680 Speaker 1: the end of the world per se. It's not an 869 00:45:16,760 --> 00:45:20,200 Speaker 1: imminent crisis. But because it is the world's most important market, 870 00:45:21,040 --> 00:45:23,560 Speaker 1: there are reasons to be concerned when you see some 871 00:45:23,680 --> 00:45:26,840 Speaker 1: of these lack of liquidity or the fragmentation that he discussed. 872 00:45:27,080 --> 00:45:30,480 Speaker 1: You know, the thing that gets me is it feels 873 00:45:30,480 --> 00:45:32,600 Speaker 1: like there are so many different moving parts that work 874 00:45:32,719 --> 00:45:36,280 Speaker 1: cross purposes. You have some laws that say treasury should 875 00:45:36,320 --> 00:45:39,879 Speaker 1: be cash, other laws that say banks can't get too big. 876 00:45:40,280 --> 00:45:44,080 Speaker 1: You have other situations in which expansive FED balance sheet 877 00:45:44,280 --> 00:45:46,920 Speaker 1: helps liquidity. On the other hand, the Fed feels it 878 00:45:47,040 --> 00:45:50,560 Speaker 1: needs to shrink its balance sheet for its monetary policy purposes, 879 00:45:51,000 --> 00:45:53,000 Speaker 1: which are all those You have all these different things 880 00:45:53,080 --> 00:45:55,800 Speaker 1: that each individually may have some logic, but it's the 881 00:45:55,960 --> 00:45:58,560 Speaker 1: confluence of all of them that see where the problems 882 00:45:58,560 --> 00:46:01,120 Speaker 1: seem to create. I think that's exactly right. Also, something 883 00:46:01,160 --> 00:46:03,840 Speaker 1: I didn't know up until recently do you know REPO 884 00:46:03,960 --> 00:46:07,239 Speaker 1: contracts are apparently exempt from the automatic stay of bankruptcy. 885 00:46:07,640 --> 00:46:09,920 Speaker 1: That was something Paul Vulker did. What does that mean? 886 00:46:10,280 --> 00:46:13,400 Speaker 1: So it means if a company goes bankrupt, they're like 887 00:46:13,600 --> 00:46:19,400 Speaker 1: repo assets don't automatically get frozen and then distributed to creditors. So, like, 888 00:46:20,520 --> 00:46:22,880 Speaker 1: you know, if you want to treat treasuries like cash. 889 00:46:23,560 --> 00:46:25,200 Speaker 1: On the other hand, if someone has a treasury that 890 00:46:25,239 --> 00:46:29,000 Speaker 1: they've used as REPO collateral in a bankruptcy, wouldn't necessarily 891 00:46:29,080 --> 00:46:32,800 Speaker 1: be distributed. Sorry, I'm getting really interest, but speak to 892 00:46:33,040 --> 00:46:35,400 Speaker 1: the issues. That's exactly right. Yeah, do we want to 893 00:46:35,440 --> 00:46:38,160 Speaker 1: treat them like cash or do we not? And should 894 00:46:38,200 --> 00:46:42,799 Speaker 1: we actually have it holistic approach towards the market? They 895 00:46:42,880 --> 00:46:46,040 Speaker 1: have to all all the regulators and policy authorities just 896 00:46:46,120 --> 00:46:47,600 Speaker 1: have to get in the same room. And it's like, 897 00:46:47,680 --> 00:46:51,560 Speaker 1: let's get on the same Yeah, okay, well, well we'll 898 00:46:51,600 --> 00:46:53,440 Speaker 1: make that happen. I'm sure. Should we leave it there? 899 00:46:53,520 --> 00:46:55,920 Speaker 1: Let's leave it there. This has been another episode of 900 00:46:56,000 --> 00:46:58,520 Speaker 1: the All Thoughts podcast. I'm Tracy Alloway. You can follow 901 00:46:58,600 --> 00:47:01,080 Speaker 1: me on Twitter at Tracy all the Way and I'm Joe. 902 00:47:01,160 --> 00:47:03,600 Speaker 1: Why isn't though You can follow me on Twitter at 903 00:47:03,640 --> 00:47:07,359 Speaker 1: the Stalwart. Follow our producer Carmen Rodriguez on Twitter She's 904 00:47:07,440 --> 00:47:10,560 Speaker 1: at Kerman Arman, and follow all of our podcast is 905 00:47:10,560 --> 00:47:14,000 Speaker 1: Bloomberg under the handle at podcasts. Thanks for listening.