1 00:00:10,680 --> 00:00:14,000 Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast. 2 00:00:14,080 --> 00:00:17,400 Speaker 1: I'm Tracy Allaway and I'm Joe Wisenthal. Joe, it's a 3 00:00:17,440 --> 00:00:17,959 Speaker 1: busy week. 4 00:00:19,520 --> 00:00:20,360 Speaker 2: It is a busy week. 5 00:00:20,400 --> 00:00:21,840 Speaker 3: It sort of snuck up on me. You know, I 6 00:00:21,880 --> 00:00:25,119 Speaker 3: knew it was FED week, like it's also jobs week. 7 00:00:25,720 --> 00:00:28,320 Speaker 3: It's also and I'm not even sure like the degree 8 00:00:28,320 --> 00:00:31,760 Speaker 3: to which it matters, quarterly refunding week sort of controversial. 9 00:00:31,880 --> 00:00:32,720 Speaker 3: There's a lot going on. 10 00:00:33,120 --> 00:00:35,120 Speaker 1: I got tipped off to the fact it was quarterly 11 00:00:35,159 --> 00:00:38,440 Speaker 1: refunding week when everyone started talking about deficits. On Monday, 12 00:00:38,760 --> 00:00:41,440 Speaker 1: you got the estimates of borrowing needs everyone. That's the 13 00:00:41,520 --> 00:00:45,000 Speaker 1: day suddenly everyone becomes really worried about the credit worthiness 14 00:00:45,920 --> 00:00:47,720 Speaker 1: the future United States of America. 15 00:00:47,960 --> 00:00:51,080 Speaker 3: There's this theory that's going around. It's kind of controversial. 16 00:00:51,120 --> 00:00:53,519 Speaker 3: I see it on Twitter sometimes that like this is 17 00:00:53,640 --> 00:00:56,840 Speaker 3: like really important for markets that like some mix of 18 00:00:56,920 --> 00:00:59,959 Speaker 3: bills and bonds and how much really matters. I don't really, 19 00:01:00,120 --> 00:01:02,480 Speaker 3: you know, I'm like sort of like skeptical, but maybe 20 00:01:02,520 --> 00:01:04,800 Speaker 3: there's something to that. But you know, a lot of 21 00:01:04,840 --> 00:01:08,000 Speaker 3: moving parts right now, and of course it is FED week. 22 00:01:08,040 --> 00:01:11,520 Speaker 3: I don't think anyone expects a rate cut but I 23 00:01:11,560 --> 00:01:15,360 Speaker 3: think the expectation is some sort of like maybe declaration 24 00:01:15,520 --> 00:01:19,400 Speaker 3: of victory and which can then be used to set 25 00:01:19,480 --> 00:01:21,000 Speaker 3: up the beginning of the cutting cycle. 26 00:01:21,200 --> 00:01:23,959 Speaker 1: Well, it's interesting you mentioned this theory about it having 27 00:01:23,959 --> 00:01:26,399 Speaker 1: a potential impact on markets, because, of course the other 28 00:01:26,480 --> 00:01:29,920 Speaker 1: thing that we expect the FED to discuss this week 29 00:01:30,200 --> 00:01:34,080 Speaker 1: is quantitative tightening, so the shrinking of the balance sheet. 30 00:01:34,120 --> 00:01:36,800 Speaker 1: And I find this is the thing that gets people 31 00:01:36,920 --> 00:01:39,720 Speaker 1: really riled up, the idea that you know, stocks are 32 00:01:39,800 --> 00:01:43,320 Speaker 1: up because of central bank liquidity and once QT begins, 33 00:01:43,400 --> 00:01:45,959 Speaker 1: it's all going to wash away and stocks are going 34 00:01:46,040 --> 00:01:49,600 Speaker 1: to fall. Of course, we haven't seen that, but we're 35 00:01:49,640 --> 00:01:52,760 Speaker 1: still waiting on a lot of additional info about the size, 36 00:01:52,840 --> 00:01:55,880 Speaker 1: the shape, the speed of QT, and there's a lot 37 00:01:55,920 --> 00:01:58,920 Speaker 1: of discussion over whether or not that could change. And 38 00:01:58,960 --> 00:02:01,200 Speaker 1: I should just say the meaning is tomorrow. But I 39 00:02:01,200 --> 00:02:02,840 Speaker 1: don't think we're going to get a lot of detail 40 00:02:02,960 --> 00:02:06,240 Speaker 1: on QT until the minutes actually come out in February. 41 00:02:06,280 --> 00:02:09,079 Speaker 1: But the point is there is loads to discuss. 42 00:02:09,360 --> 00:02:11,280 Speaker 3: Yeah, totally, you know. And the one thing I'll say 43 00:02:11,320 --> 00:02:14,000 Speaker 3: to on the balance sheet, I'll say two things. One is, 44 00:02:14,400 --> 00:02:16,000 Speaker 3: for a long time, it was just the story the 45 00:02:16,040 --> 00:02:18,480 Speaker 3: FED is pumping money into the markets, and as soon 46 00:02:18,520 --> 00:02:21,360 Speaker 3: as the balance sheet starts to shrink, then that's going 47 00:02:21,400 --> 00:02:24,040 Speaker 3: to be bad for risk assets. That, in my opinion, 48 00:02:24,080 --> 00:02:27,400 Speaker 3: has now officially been disproven because the balance sheet has 49 00:02:27,400 --> 00:02:30,000 Speaker 3: been shrinking basically since the middle of twenty twenty two 50 00:02:30,360 --> 00:02:33,160 Speaker 3: and stocks are at all time high. So that's over 51 00:02:33,280 --> 00:02:35,800 Speaker 3: that story. It's a thesis is broken in my opinion. 52 00:02:35,840 --> 00:02:38,840 Speaker 3: But what it means for banks, what it means for 53 00:02:38,919 --> 00:02:42,360 Speaker 3: bank liquidity, how far they can shrink it before it 54 00:02:42,440 --> 00:02:45,079 Speaker 3: creates problems such as what we talked about I think 55 00:02:45,120 --> 00:02:48,560 Speaker 3: it was in twenty nineteen. This still matters quite a 56 00:02:48,600 --> 00:02:51,960 Speaker 3: bit and they're still interesting policy questions related to that. 57 00:02:52,320 --> 00:02:56,519 Speaker 1: Absolutely, So who better to discuss all of these issues 58 00:02:56,960 --> 00:03:00,959 Speaker 1: than Mark Cabana, rates strategist over at Bank of America. Mark, 59 00:03:01,000 --> 00:03:02,440 Speaker 1: thank you so much for coming on the show. 60 00:03:02,520 --> 00:03:03,240 Speaker 2: Thanks for having me. 61 00:03:03,639 --> 00:03:07,480 Speaker 1: We are a longtime fans of your work, and it's 62 00:03:07,600 --> 00:03:09,080 Speaker 1: kind of a treat for us that we could do 63 00:03:09,160 --> 00:03:11,880 Speaker 1: this and release the episode on the day of the 64 00:03:11,919 --> 00:03:14,440 Speaker 1: FED meeting, So we're recording it just the day before, 65 00:03:14,800 --> 00:03:16,840 Speaker 1: so we're going to get all your thoughts on what's 66 00:03:16,880 --> 00:03:19,920 Speaker 1: going on at the moment. But with your rates hat on. 67 00:03:20,639 --> 00:03:22,720 Speaker 1: When you look at a week like this, when you 68 00:03:22,800 --> 00:03:25,400 Speaker 1: have the QRA, you have jobs, you have the Fed, 69 00:03:26,080 --> 00:03:28,720 Speaker 1: what are you most interested in? How are you weighing 70 00:03:28,760 --> 00:03:29,720 Speaker 1: those different events? 71 00:03:30,040 --> 00:03:32,200 Speaker 2: Sure? Well, thanks for having me. I'm also a big fan, 72 00:03:32,320 --> 00:03:34,320 Speaker 2: so it's a real thrill to be here. Thank you. 73 00:03:34,639 --> 00:03:36,720 Speaker 2: So when we think about the rates outlook, we think 74 00:03:36,800 --> 00:03:39,440 Speaker 2: that the expected path of the overnight rate is really 75 00:03:39,480 --> 00:03:42,240 Speaker 2: the most important determinant of where rates go. Henceforth, the 76 00:03:42,240 --> 00:03:45,280 Speaker 2: Fed is clearly the most important consideration for us this week. 77 00:03:45,960 --> 00:03:48,520 Speaker 2: The payroll report and other date of this week will 78 00:03:48,520 --> 00:03:51,760 Speaker 2: inform that and then still important, but perhaps secondary, is 79 00:03:51,760 --> 00:03:54,560 Speaker 2: the quarterly refunding from the Treasury that supply announcement. Though 80 00:03:54,600 --> 00:03:57,640 Speaker 2: I agree with Joe, it has certainly been a focus 81 00:03:57,760 --> 00:04:00,560 Speaker 2: in markets, and probably much more so than the Treasury 82 00:04:00,600 --> 00:04:03,480 Speaker 2: ever would have wanted. And that's really because they've surprised 83 00:04:03,480 --> 00:04:05,520 Speaker 2: the market with the last two refundings. 84 00:04:05,600 --> 00:04:08,040 Speaker 1: Oh that's right, because it wasn't it the August refunding 85 00:04:08,040 --> 00:04:11,960 Speaker 1: announcement that kicked off that initial big surge in bond yields, 86 00:04:11,960 --> 00:04:13,600 Speaker 1: and then it was the November one that kind of 87 00:04:13,600 --> 00:04:14,400 Speaker 1: calmed things down. 88 00:04:14,640 --> 00:04:17,880 Speaker 2: So yes, that's generally right. So they surprised by issuing 89 00:04:18,120 --> 00:04:21,200 Speaker 2: more longer dated coupons in the August refunding. They then 90 00:04:21,240 --> 00:04:24,400 Speaker 2: surprised by issuing fewer long dated coupons in the November 91 00:04:24,400 --> 00:04:27,719 Speaker 2: of funding, and this was seen by the market as 92 00:04:27,760 --> 00:04:31,400 Speaker 2: a factor that was a meaningful driver of where term 93 00:04:31,480 --> 00:04:34,080 Speaker 2: premium was going. Now, I'm using air quotes as I 94 00:04:34,120 --> 00:04:36,280 Speaker 2: say that. I know your listeners can't see the air quotes, 95 00:04:36,920 --> 00:04:38,880 Speaker 2: but that is because the term premium is sort of 96 00:04:38,880 --> 00:04:42,880 Speaker 2: this catch all, unexplained factor, at least by certain FED models, 97 00:04:43,279 --> 00:04:45,479 Speaker 2: and I think one can view term premium with a 98 00:04:45,480 --> 00:04:49,040 Speaker 2: healthy dose of skepticism. But nevertheless, the market perceived that 99 00:04:49,080 --> 00:04:53,040 Speaker 2: those supply announcements were big drivers of movements in term premium. 100 00:04:53,480 --> 00:04:58,080 Speaker 3: By the way, for listeners, Tracy, that was a minute ago. 101 00:04:58,160 --> 00:05:00,800 Speaker 3: I was drum rolling that sound because I always love 102 00:05:01,040 --> 00:05:05,280 Speaker 3: when eminent guests confirm my biases. So nothing feels better 103 00:05:05,320 --> 00:05:09,839 Speaker 3: than that. Setting aside market perception in your own work, 104 00:05:10,600 --> 00:05:13,920 Speaker 3: how important was the mix? So I guess there's two elements. 105 00:05:14,240 --> 00:05:17,480 Speaker 3: Just the total size of the borrowing each quarter, which 106 00:05:17,520 --> 00:05:20,599 Speaker 3: is just a sort of economic reality that is just 107 00:05:20,720 --> 00:05:23,600 Speaker 3: you know, the gap between expenditures and the amount the 108 00:05:23,640 --> 00:05:26,360 Speaker 3: government brings into taxes, and then there is okay, there's 109 00:05:26,360 --> 00:05:28,560 Speaker 3: that mix that you described, how much is the Treasury 110 00:05:28,600 --> 00:05:30,720 Speaker 3: going to issue at the long end versus the short end? 111 00:05:30,960 --> 00:05:33,719 Speaker 3: How important are these things too, setting aside what the 112 00:05:33,720 --> 00:05:37,120 Speaker 3: market perceives or even what the market did, like what 113 00:05:37,240 --> 00:05:39,719 Speaker 3: when you see these announcements, like what are you looking for? 114 00:05:39,760 --> 00:05:40,560 Speaker 3: And how significant? 115 00:05:41,160 --> 00:05:43,960 Speaker 2: So they certainly matter in terms of the relative mix 116 00:05:43,960 --> 00:05:45,360 Speaker 2: of what treasure is going to issue and how the 117 00:05:45,400 --> 00:05:47,120 Speaker 2: private sector is going to take that down, But in 118 00:05:47,200 --> 00:05:49,800 Speaker 2: terms of determining the overall direction of bond yields, we 119 00:05:49,800 --> 00:05:52,880 Speaker 2: think that they are secondary important, but secondary, and what's 120 00:05:52,880 --> 00:05:58,080 Speaker 2: more important is macroeconomic information, growth, inflation, jobs, et cetera, 121 00:05:58,440 --> 00:06:01,000 Speaker 2: and how that's expected to impact the overall path of 122 00:06:01,440 --> 00:06:03,760 Speaker 2: the FED. And what we saw really in the third 123 00:06:03,839 --> 00:06:06,640 Speaker 2: quarter was, yes, you did get a larger than expected 124 00:06:06,680 --> 00:06:09,120 Speaker 2: supply announcement from the Treasury, but you also had nominal 125 00:06:09,160 --> 00:06:11,960 Speaker 2: GDP that was running at about five percent real nine 126 00:06:12,000 --> 00:06:16,680 Speaker 2: percent nominal that we think was the much larger driver 127 00:06:16,960 --> 00:06:20,360 Speaker 2: of the movement in rates. Treasury supply announcement didn't help, 128 00:06:20,520 --> 00:06:23,480 Speaker 2: but again we think that the sharp upward moving rates 129 00:06:23,520 --> 00:06:26,120 Speaker 2: was largely driven by better data, and conversely, in the 130 00:06:26,120 --> 00:06:29,800 Speaker 2: fourth quarter data moderated to some extent, the Fed turned 131 00:06:29,839 --> 00:06:32,640 Speaker 2: more dubvish. The Treasury surprise to the downside on supply, 132 00:06:32,760 --> 00:06:34,880 Speaker 2: and that helped reverse some of the big move that 133 00:06:34,920 --> 00:06:38,799 Speaker 2: we saw in late summer early fall. So these supply 134 00:06:38,800 --> 00:06:41,920 Speaker 2: announcements from Treasury, they do matter. They influence market perception. 135 00:06:42,240 --> 00:06:45,120 Speaker 2: They certainly matter in terms of how investors think about 136 00:06:45,320 --> 00:06:46,880 Speaker 2: how much supply they're going to have to take down, 137 00:06:46,920 --> 00:06:49,120 Speaker 2: how aggressive or not they are to bid, how dealers 138 00:06:49,160 --> 00:06:51,800 Speaker 2: manage the inventory on their balance sheets. But generally speaking, 139 00:06:51,800 --> 00:06:54,200 Speaker 2: we do think it's a secondary factor, secondary to the 140 00:06:54,440 --> 00:06:58,240 Speaker 2: incoming economic data that influences the expected path policy mark. 141 00:06:58,360 --> 00:07:00,680 Speaker 1: One of the other narratives that it became kind of 142 00:07:00,680 --> 00:07:02,960 Speaker 1: popular over the past year or so was this idea 143 00:07:03,040 --> 00:07:06,640 Speaker 1: of who is going to buy the bonds. So, you know, 144 00:07:06,680 --> 00:07:11,200 Speaker 1: with inflation rising, with the deficit growing, with a lot 145 00:07:11,240 --> 00:07:15,520 Speaker 1: of natural buyers potentially stepping back, maybe some geopolitical concerns 146 00:07:15,560 --> 00:07:18,960 Speaker 1: mixed in there, there was this narrative that the traditional 147 00:07:19,000 --> 00:07:23,080 Speaker 1: buying base of US Treasury debt wouldn't be as large 148 00:07:23,320 --> 00:07:26,280 Speaker 1: as it had been previously. And yet fast forward to 149 00:07:26,320 --> 00:07:28,600 Speaker 1: the end of twenty twenty three, we had bond yields 150 00:07:28,600 --> 00:07:31,440 Speaker 1: on the tenure basically taking a round trip. They're a 151 00:07:31,480 --> 00:07:33,840 Speaker 1: little over four percent right now. What do you think 152 00:07:33,880 --> 00:07:35,600 Speaker 1: about that particular narrative. 153 00:07:35,920 --> 00:07:37,920 Speaker 2: Yeah, So, the number one question that we were getting 154 00:07:37,960 --> 00:07:40,040 Speaker 2: over the course of twenty twenty three is indeed, who's 155 00:07:40,080 --> 00:07:43,280 Speaker 2: going to buy the bonds? And it is a challenging 156 00:07:43,360 --> 00:07:46,720 Speaker 2: question to answer when you are seeing inflation surprise to 157 00:07:46,760 --> 00:07:49,240 Speaker 2: the upside, when the FED is more hawkish than expected, 158 00:07:49,600 --> 00:07:52,880 Speaker 2: and when bond yields are losing value. No surprise, investors 159 00:07:52,880 --> 00:07:55,600 Speaker 2: don't really want to buy bonds when they're not holding 160 00:07:55,680 --> 00:07:58,200 Speaker 2: their value, and as a result of that, we did 161 00:07:58,240 --> 00:08:01,400 Speaker 2: see that demand weakened from a whole host of traditional 162 00:08:01,400 --> 00:08:04,120 Speaker 2: investors over the course of twenty twenty three, though they 163 00:08:04,120 --> 00:08:07,320 Speaker 2: did come back to some extent towards the tail end. Now, 164 00:08:07,320 --> 00:08:08,920 Speaker 2: when we think about who's going to buy the bonds, 165 00:08:08,960 --> 00:08:13,440 Speaker 2: we really think about maybe four or five traditional buyer bases, banks, 166 00:08:14,000 --> 00:08:19,600 Speaker 2: pensions and insures, overseas investors, asset managers, and then the FED, 167 00:08:19,960 --> 00:08:21,800 Speaker 2: and whether or not they are buying or selling at 168 00:08:21,800 --> 00:08:24,120 Speaker 2: any particular point in time. They're obviously selling right now 169 00:08:24,720 --> 00:08:28,000 Speaker 2: for those buyer bases. We really saw transformation in twenty 170 00:08:28,040 --> 00:08:31,240 Speaker 2: twenty three from those who really had stepped away from 171 00:08:31,280 --> 00:08:34,120 Speaker 2: the market largely in the first three quarters of the years, 172 00:08:34,320 --> 00:08:37,840 Speaker 2: or some that had tried to buy tens at let's 173 00:08:37,840 --> 00:08:40,680 Speaker 2: say four percent and then got burned as tens rose 174 00:08:40,760 --> 00:08:43,120 Speaker 2: much more materially over the course of the year, and 175 00:08:43,120 --> 00:08:46,120 Speaker 2: they had really taken a step back. But once we 176 00:08:46,200 --> 00:08:51,480 Speaker 2: saw macroeconomic data, certainly inflation data, confirmed that the peak 177 00:08:51,480 --> 00:08:53,560 Speaker 2: and inflation was over, that the FED was not going 178 00:08:53,600 --> 00:08:56,320 Speaker 2: to be hiking much more likely next step would be cutting, 179 00:08:56,720 --> 00:08:59,520 Speaker 2: we saw that demand return quite meaningfully. And we've seen 180 00:08:59,559 --> 00:09:03,200 Speaker 2: that from those traditional buyer bases. Banks commercial banks have 181 00:09:03,240 --> 00:09:07,480 Speaker 2: stepped into the market moderately. Pensions and insurers we see 182 00:09:07,520 --> 00:09:12,000 Speaker 2: they have generated the largest amount of stripping activity. A stripping, remember, 183 00:09:12,040 --> 00:09:15,080 Speaker 2: is when you separate a long term treasury security into 184 00:09:15,080 --> 00:09:18,760 Speaker 2: a principal component and an interest component. They like to 185 00:09:18,760 --> 00:09:22,520 Speaker 2: buy the principal components because they're essentially zero coupon bullets. 186 00:09:22,600 --> 00:09:25,040 Speaker 2: After they've been stripped, they have low dollar values, they 187 00:09:25,080 --> 00:09:28,120 Speaker 2: can add duration easily, and that helps them manage their 188 00:09:28,240 --> 00:09:32,120 Speaker 2: overall liability mix. But that pension and insurance community, we 189 00:09:32,160 --> 00:09:35,040 Speaker 2: think is stepped back a bit. Some foreign demand has 190 00:09:35,080 --> 00:09:37,800 Speaker 2: re emerged, not from Japan, not from China, but from 191 00:09:37,840 --> 00:09:41,880 Speaker 2: other parts of the world has emerged. And we've also 192 00:09:41,960 --> 00:09:45,400 Speaker 2: seen that asset managers have been returning back to the 193 00:09:45,440 --> 00:09:48,760 Speaker 2: market as yield stop rising. We're also now talking about 194 00:09:48,800 --> 00:09:51,960 Speaker 2: the possibility that the FED will go from as active 195 00:09:52,000 --> 00:09:55,280 Speaker 2: of a net seller through QT. They don't functionally sell 196 00:09:55,320 --> 00:09:58,160 Speaker 2: into the secondary market, but they're responsible for more supply 197 00:09:58,280 --> 00:10:00,160 Speaker 2: that the US Treasury in turn has to issue the 198 00:10:00,160 --> 00:10:03,839 Speaker 2: private sector. And they're talking about slowing QT, and now 199 00:10:03,840 --> 00:10:06,199 Speaker 2: we're wondering what if they're slowing, when might they stop? 200 00:10:06,600 --> 00:10:10,000 Speaker 2: So that is an important determinant in shifting some of 201 00:10:10,040 --> 00:10:12,800 Speaker 2: the supply demand dynamics in the rates market. So that's 202 00:10:12,800 --> 00:10:14,600 Speaker 2: a long winded way of saying that we have seen 203 00:10:14,640 --> 00:10:18,840 Speaker 2: those supply and demand dynamics shift. Really demand is returned 204 00:10:18,880 --> 00:10:21,760 Speaker 2: to some extent, and we remain cautiously optimistic that that 205 00:10:21,800 --> 00:10:24,000 Speaker 2: demand will persist over the course of twenty twenty four, 206 00:10:24,320 --> 00:10:27,320 Speaker 2: assuming that macroeconomic data continues to play along with the 207 00:10:27,360 --> 00:10:30,079 Speaker 2: broad narrative of slow moderation over time. 208 00:10:30,640 --> 00:10:34,320 Speaker 3: Let's talk about quantitative tightening. You know, like I said 209 00:10:34,320 --> 00:10:36,439 Speaker 3: in the beginning, there's always been like this one. I 210 00:10:36,440 --> 00:10:38,480 Speaker 3: guess I would call it like Twitter macro or it's 211 00:10:38,520 --> 00:10:40,680 Speaker 3: like one line goes up, another line goes up. They 212 00:10:40,760 --> 00:10:43,000 Speaker 3: must be connected. And I think the idea that like 213 00:10:43,400 --> 00:10:46,480 Speaker 3: balance sheet policy is some incredible driver of risk asset 214 00:10:46,600 --> 00:10:51,040 Speaker 3: valuation is kind of debunked. But when we're discussing how 215 00:10:51,120 --> 00:10:54,000 Speaker 3: far they will go to wind down and at what 216 00:10:54,160 --> 00:10:56,680 Speaker 3: level that will be, who does that really matter for 217 00:10:56,800 --> 00:10:59,000 Speaker 3: and why? Like, who are the actors in the market 218 00:10:59,240 --> 00:11:02,320 Speaker 3: that for whom this is an important debate that they're having. 219 00:11:02,520 --> 00:11:04,800 Speaker 2: Sure, I generally think of two or three actors for 220 00:11:04,840 --> 00:11:06,840 Speaker 2: which it really matters in terms of how far the 221 00:11:06,880 --> 00:11:10,480 Speaker 2: FED shrinks the balance sheet. First and foremost commercial banks, 222 00:11:10,800 --> 00:11:13,640 Speaker 2: because they can be directly impacted by the amount of 223 00:11:13,880 --> 00:11:16,839 Speaker 2: reserves or overnight liquidity that the FED is providing two 224 00:11:16,960 --> 00:11:19,440 Speaker 2: commercial banks, or that it's available in the system that 225 00:11:19,480 --> 00:11:23,520 Speaker 2: commercial banks can try and bid for. The second big 226 00:11:23,559 --> 00:11:27,520 Speaker 2: actor is treasury and mortgage market participants, for whom if 227 00:11:27,520 --> 00:11:29,559 Speaker 2: the FED is shrinking its balance sheet or growing its 228 00:11:29,559 --> 00:11:32,640 Speaker 2: balance sheet, the total amount of private sector supply in 229 00:11:32,679 --> 00:11:35,599 Speaker 2: the treasury or agency mortgage market can be directly influenced 230 00:11:35,640 --> 00:11:38,199 Speaker 2: by that. And then the third cohort, and Joe, I 231 00:11:38,240 --> 00:11:40,040 Speaker 2: think your comments have referred to this on a few 232 00:11:40,040 --> 00:11:42,719 Speaker 2: times as sort of the broader risk asset investor. I 233 00:11:42,760 --> 00:11:44,839 Speaker 2: almost think of them as the quote unquote M two 234 00:11:45,000 --> 00:11:48,040 Speaker 2: equity investor, the type of equity investor who just wants 235 00:11:48,120 --> 00:11:50,680 Speaker 2: to buy or sell equities based upon what's happening with 236 00:11:50,679 --> 00:11:53,640 Speaker 2: the broader money supply. And this, I will tell you, 237 00:11:53,840 --> 00:11:56,880 Speaker 2: is a very real cohort of the market, at least 238 00:11:56,880 --> 00:11:59,240 Speaker 2: as far as the folks who reach out to us 239 00:11:59,640 --> 00:12:02,160 Speaker 2: on the b A rate strategy team. We also view 240 00:12:02,200 --> 00:12:04,640 Speaker 2: it with a healthy dose of skepticism. We don't believe 241 00:12:04,679 --> 00:12:07,760 Speaker 2: that there is a particular clear connection between how many reserves, 242 00:12:07,800 --> 00:12:09,880 Speaker 2: let's say, are in the banking system and then what's 243 00:12:09,880 --> 00:12:12,800 Speaker 2: going to happen with the equity market. But that doesn't 244 00:12:12,800 --> 00:12:15,079 Speaker 2: dissuade them. They look back at history and they say, well, 245 00:12:15,080 --> 00:12:17,320 Speaker 2: when the FED was growing its balance sheet, risk assets 246 00:12:17,320 --> 00:12:19,840 Speaker 2: did well. When they shrunk the balance sheet or reserves 247 00:12:19,880 --> 00:12:22,760 Speaker 2: went down, the opposite happened. And really, what we think 248 00:12:22,800 --> 00:12:25,200 Speaker 2: they are picking up on is the fact that the 249 00:12:25,240 --> 00:12:28,000 Speaker 2: FED and other central banks use their balance sheets to 250 00:12:28,040 --> 00:12:31,800 Speaker 2: almost reinforce the broader stances of monetary policy. So if 251 00:12:31,840 --> 00:12:34,040 Speaker 2: they're growing the balance sheet, they're typically doing so because 252 00:12:34,040 --> 00:12:36,840 Speaker 2: they're trying to stimulate activity lower long term borrowing costs. 253 00:12:37,040 --> 00:12:38,720 Speaker 2: And if they shrink the balance sheet, they're generally trying 254 00:12:38,760 --> 00:12:40,640 Speaker 2: to tighten policy and they're raising interest rates at the 255 00:12:40,679 --> 00:12:43,240 Speaker 2: same time. So if you think about the balance sheet 256 00:12:43,240 --> 00:12:46,000 Speaker 2: as reinforcing the broad stance of monetary policy, we think 257 00:12:46,040 --> 00:12:48,959 Speaker 2: that the MT equity trading stance makes sense. But we 258 00:12:48,960 --> 00:12:51,800 Speaker 2: would encourage investors not to blindly follow what happens with 259 00:12:51,960 --> 00:12:54,360 Speaker 2: the balance sheet or with the reserve quantity and the 260 00:12:54,400 --> 00:12:57,440 Speaker 2: system as an indicator of buying or selling risks. 261 00:13:12,640 --> 00:13:15,920 Speaker 1: There's one sort of under the radar thing at the 262 00:13:15,920 --> 00:13:17,439 Speaker 1: moment that I think is going to end up being 263 00:13:17,440 --> 00:13:19,640 Speaker 1: a big deal in twenty twenty four, which is sort 264 00:13:19,679 --> 00:13:25,000 Speaker 1: of the changes around liquidity requirements and regulation for banks 265 00:13:25,200 --> 00:13:29,200 Speaker 1: and all of that happening against the broader backdrop of QT. 266 00:13:29,840 --> 00:13:32,120 Speaker 1: But how do you see that playing out? Because there's 267 00:13:32,120 --> 00:13:34,959 Speaker 1: a number of things here, so you know, there are 268 00:13:35,160 --> 00:13:39,200 Speaker 1: the basil endgame proposals, there are LCR suggestions that maybe 269 00:13:39,520 --> 00:13:42,440 Speaker 1: make those liquidity ratios get a little bit bigger. There's 270 00:13:42,600 --> 00:13:44,800 Speaker 1: changes to I have to be careful here because I 271 00:13:44,840 --> 00:13:50,360 Speaker 1: always end up saying bt FD, the BTFP, not by 272 00:13:50,559 --> 00:13:56,960 Speaker 1: the F dick the BTFP and a few other things 273 00:13:56,960 --> 00:13:57,840 Speaker 1: happening in the back end. 274 00:13:59,080 --> 00:14:02,160 Speaker 3: So funny that this was a market mantra for like 275 00:14:02,200 --> 00:14:05,000 Speaker 3: fifteen years, and then the FED came out with an 276 00:14:05,000 --> 00:14:09,080 Speaker 3: emergency program in March twenty twenty three that sounded so similar, Like, 277 00:14:09,160 --> 00:14:11,319 Speaker 3: let's just acknowledge that is very funny. I never even 278 00:14:11,400 --> 00:14:14,720 Speaker 3: heard of that other acronym BTFD. You need to spend 279 00:14:14,920 --> 00:14:18,040 Speaker 3: more time online, dear FED. You know, I want to 280 00:14:18,440 --> 00:14:19,040 Speaker 3: look at Twitter. 281 00:14:19,240 --> 00:14:20,560 Speaker 2: Okay, next day. 282 00:14:20,840 --> 00:14:22,760 Speaker 3: We just acknowledge the elephant in the room. 283 00:14:22,880 --> 00:14:25,440 Speaker 1: I'm glad we introduced mark to thank you. 284 00:14:25,480 --> 00:14:26,080 Speaker 2: I learned something. 285 00:14:26,120 --> 00:14:28,000 Speaker 1: I appreciate it all right, But it does feel like 286 00:14:28,240 --> 00:14:31,680 Speaker 1: changes are coming for the banks. And banks are big 287 00:14:31,720 --> 00:14:35,880 Speaker 1: buyers of things like treasury bonds and mortgage backed securities 288 00:14:35,880 --> 00:14:37,480 Speaker 1: and things like that. So how do you see all 289 00:14:37,520 --> 00:14:38,640 Speaker 1: of that playing out? 290 00:14:39,080 --> 00:14:43,600 Speaker 2: Sure, So we do think that importantly with the recent 291 00:14:43,920 --> 00:14:47,160 Speaker 2: rate hiking cycle from the FED and what we saw 292 00:14:47,200 --> 00:14:51,760 Speaker 2: with SVB and some other regional banks, that commercial banks 293 00:14:51,760 --> 00:14:56,320 Speaker 2: have really changed their preferences around liquidity in a meaningful way. 294 00:14:56,920 --> 00:15:00,280 Speaker 2: And this we think will necessitate that the FED maintain 295 00:15:00,360 --> 00:15:02,960 Speaker 2: a much larger balance sheet than perhaps they had originally 296 00:15:03,080 --> 00:15:07,920 Speaker 2: envisioned to really accommodate this demand for overnight liquidity from 297 00:15:07,960 --> 00:15:12,520 Speaker 2: commercial banks. And we think that commercial banks are demanding 298 00:15:12,680 --> 00:15:16,560 Speaker 2: much more overnight liquidity for very rational and prudent reasons. 299 00:15:17,120 --> 00:15:21,200 Speaker 2: The four factors that we typically cite include Number one, 300 00:15:21,520 --> 00:15:24,520 Speaker 2: we all saw what happened with SVB, and the best 301 00:15:24,560 --> 00:15:27,920 Speaker 2: antidote for that, we would argue, is holding lots of 302 00:15:27,960 --> 00:15:32,000 Speaker 2: overnight liquidity. Number two, commercial banks are still sitting on 303 00:15:32,080 --> 00:15:37,240 Speaker 2: fairly substantial unrealized securities losses and their treasury and mortgage portfolios. 304 00:15:37,240 --> 00:15:39,560 Speaker 2: The recent rate rally has helped ameliorate that, but it 305 00:15:39,600 --> 00:15:42,080 Speaker 2: hasn't gone away. And again, the best way to fight 306 00:15:42,160 --> 00:15:45,480 Speaker 2: against those unrealized securities sowces is to hold cash. You 307 00:15:45,480 --> 00:15:48,560 Speaker 2: can tell your shareholders or your regulators, don't worry about 308 00:15:48,560 --> 00:15:50,680 Speaker 2: the two and a half percent mortgage or so that 309 00:15:50,760 --> 00:15:52,720 Speaker 2: I bought. I'm never going to have to sell that 310 00:15:53,080 --> 00:15:57,120 Speaker 2: for liquidity purposes. Because I'm holding onto so much overnight 311 00:15:57,160 --> 00:16:00,600 Speaker 2: cash and I have so many deposits, we don't worry 312 00:16:00,640 --> 00:16:03,480 Speaker 2: about those securities. We think that's very rational in this 313 00:16:03,560 --> 00:16:07,200 Speaker 2: type of rate environment. Third reason that banks are holding 314 00:16:07,360 --> 00:16:10,880 Speaker 2: more liquidity is because they perceive that some of the 315 00:16:11,080 --> 00:16:15,200 Speaker 2: traditional rules of liquidity management have changed. And this goes 316 00:16:15,240 --> 00:16:18,600 Speaker 2: into a fairly narrow corner of the funding markets, but 317 00:16:18,600 --> 00:16:21,080 Speaker 2: it's very important, and it's around the role of the 318 00:16:21,120 --> 00:16:26,760 Speaker 2: Federal Home Loan Banking System GSE that arguably had really 319 00:16:26,800 --> 00:16:31,560 Speaker 2: shifted from its original intention to be a low cost, 320 00:16:31,760 --> 00:16:37,920 Speaker 2: stable provider of funding for bank mortgage holdings, and regulators 321 00:16:38,080 --> 00:16:42,160 Speaker 2: are well, they've asked, does this evolution of the home 322 00:16:42,160 --> 00:16:46,840 Speaker 2: loan system make sense? They think, not necessarily, and that 323 00:16:46,880 --> 00:16:51,680 Speaker 2: has really reduced the ability or willingness for banks to 324 00:16:51,800 --> 00:16:54,320 Speaker 2: use the home loan system as a traditional funding source. 325 00:16:54,800 --> 00:16:56,920 Speaker 2: The market calls the home loans, or at least the 326 00:16:56,960 --> 00:16:59,560 Speaker 2: home loans have called themselves in the past, the lender 327 00:16:59,600 --> 00:17:03,920 Speaker 2: of second to last resort, and that is now, let's say, 328 00:17:04,080 --> 00:17:07,119 Speaker 2: not necessarily your second to last resort. It is lower 329 00:17:07,119 --> 00:17:10,520 Speaker 2: on the priority list to be used. And then the 330 00:17:10,560 --> 00:17:12,960 Speaker 2: fourth and final factor is that there is a perception, 331 00:17:13,040 --> 00:17:15,560 Speaker 2: as you say, Tracy, that there will be additional liquidity 332 00:17:15,880 --> 00:17:19,159 Speaker 2: rules and regulations coming down the pike, and all of 333 00:17:19,200 --> 00:17:23,159 Speaker 2: those factors encourage banks to want to hold more liquidity, 334 00:17:23,440 --> 00:17:25,919 Speaker 2: and the best type of liquidity in the world if 335 00:17:25,920 --> 00:17:29,520 Speaker 2: you're a bank for all of these reasons, is cash 336 00:17:29,560 --> 00:17:32,680 Speaker 2: at the FED. It is intra day liquid and if 337 00:17:32,720 --> 00:17:34,760 Speaker 2: you need it, if you were to experience a large 338 00:17:34,800 --> 00:17:37,480 Speaker 2: deposit outflow, you have it at the FED. You can 339 00:17:37,560 --> 00:17:40,840 Speaker 2: get it on demand as long as FED wire is opened, 340 00:17:41,359 --> 00:17:45,320 Speaker 2: and that has real value if you are a commercial bank. 341 00:17:45,720 --> 00:17:48,440 Speaker 2: And as a result of that, commercial banks have been 342 00:17:48,640 --> 00:17:52,600 Speaker 2: choosing to hold a lot more liquidity. They've been paying 343 00:17:52,680 --> 00:17:57,159 Speaker 2: up through more elevated sources of borrowing such as large 344 00:17:57,200 --> 00:18:01,320 Speaker 2: time deposits, CDs, other forms of termed at borrowing, and 345 00:18:01,560 --> 00:18:04,600 Speaker 2: they have been doing that in order to hold more cash. 346 00:18:04,880 --> 00:18:09,520 Speaker 2: And that indicates to us this increased preference to hold liquidity. 347 00:18:09,920 --> 00:18:12,120 Speaker 2: And if that is indeed right, it's going to mean 348 00:18:12,119 --> 00:18:14,520 Speaker 2: that the FED is unable to shrink its balance sheet, 349 00:18:14,560 --> 00:18:17,919 Speaker 2: perhaps as far as it had originally thought. Now, the 350 00:18:18,000 --> 00:18:21,760 Speaker 2: question in our minds is will the FED slow down 351 00:18:21,920 --> 00:18:25,920 Speaker 2: or stop in time to accommodate this, or will they 352 00:18:26,080 --> 00:18:30,840 Speaker 2: risk another funding market increase or sharp jump like we 353 00:18:30,880 --> 00:18:34,359 Speaker 2: saw in September twenty nineteen. We don't know the answer 354 00:18:34,400 --> 00:18:36,840 Speaker 2: to that yet, but folks like me who focus a 355 00:18:36,840 --> 00:18:39,920 Speaker 2: lot on the plumbing, are very very interested in the 356 00:18:39,960 --> 00:18:42,720 Speaker 2: guidance that we're going to get from Powell and others 357 00:18:42,760 --> 00:18:46,320 Speaker 2: at the FED as they move forward in this debate 358 00:18:46,359 --> 00:18:47,200 Speaker 2: and this discussion. 359 00:18:47,800 --> 00:18:51,560 Speaker 1: Since you mentioned the plumbing, you're talking essentially about the 360 00:18:52,080 --> 00:18:56,719 Speaker 1: repo madness of twenty nineteen. And then we saw a little, 361 00:18:57,240 --> 00:19:00,080 Speaker 1: i don't want to say repeat, but a little glimmer 362 00:19:00,200 --> 00:19:03,680 Speaker 1: of that same issue in I think it was December 363 00:19:04,119 --> 00:19:08,080 Speaker 1: of last year when we saw not libor, but so 364 00:19:08,280 --> 00:19:12,359 Speaker 1: for the libor replacement rate shoot up kind of unexpectedly 365 00:19:12,600 --> 00:19:14,840 Speaker 1: in a few days and then come down very quickly. 366 00:19:15,400 --> 00:19:18,280 Speaker 1: What was going on there in your mind? And how 367 00:19:18,440 --> 00:19:22,359 Speaker 1: much of a concern should future volatility in the interbank 368 00:19:22,640 --> 00:19:26,400 Speaker 1: lending market be for those at the FED and US 369 00:19:26,480 --> 00:19:27,560 Speaker 1: market commentators. 370 00:19:27,800 --> 00:19:30,960 Speaker 2: Sure? So, Just a quick point of fact, libor was 371 00:19:30,960 --> 00:19:34,000 Speaker 2: indeed unsecured interbank funding, or at least that's what it 372 00:19:34,000 --> 00:19:37,879 Speaker 2: was intended to be. So is importantly secured funding that 373 00:19:37,960 --> 00:19:41,320 Speaker 2: has arguably a wider range of actors involved in that 374 00:19:41,480 --> 00:19:45,040 Speaker 2: money market. Mutual funds who are lending cash in that market, 375 00:19:45,440 --> 00:19:48,080 Speaker 2: hedge funds who are demanding leverage on the borrowing side 376 00:19:48,080 --> 00:19:50,919 Speaker 2: in that market. So it is a fundamentally different space, 377 00:19:51,600 --> 00:19:53,520 Speaker 2: but we do think that signals from money markets are 378 00:19:53,600 --> 00:19:58,400 Speaker 2: very important indicators of what this demand for liquidity at 379 00:19:58,440 --> 00:20:01,760 Speaker 2: commercial banks looks like and how much excess cash may 380 00:20:01,800 --> 00:20:06,200 Speaker 2: be available to keep money markets in check. Now, how 381 00:20:06,200 --> 00:20:10,240 Speaker 2: does this actually work. Well, here's our understanding of it. 382 00:20:10,800 --> 00:20:12,680 Speaker 2: So when we think about the reboul market, we think 383 00:20:12,800 --> 00:20:15,280 Speaker 2: very simply about it. It's nothing more than the relative 384 00:20:15,280 --> 00:20:18,040 Speaker 2: balance of cash that is available to be invested in 385 00:20:18,080 --> 00:20:22,040 Speaker 2: short term money markets and collateral that needs to be funded. Really, 386 00:20:22,119 --> 00:20:24,560 Speaker 2: treasury collateral is the most frequent type of collateral that 387 00:20:24,600 --> 00:20:26,560 Speaker 2: we think of, but there's a whole host of other 388 00:20:26,640 --> 00:20:31,080 Speaker 2: collateral that gets funded mortgages, credit em etc. But again, 389 00:20:31,119 --> 00:20:32,960 Speaker 2: we just think about it as in terms of cash 390 00:20:33,040 --> 00:20:37,560 Speaker 2: and collateral. And what we saw at the end of December, 391 00:20:37,680 --> 00:20:40,520 Speaker 2: also what we saw at the end of November is 392 00:20:40,600 --> 00:20:44,080 Speaker 2: that we saw rebo rates spike for a period of time. 393 00:20:44,160 --> 00:20:46,720 Speaker 2: In our framework, that simply indicates that there is less 394 00:20:46,760 --> 00:20:50,879 Speaker 2: cash that's available to fund the collateral that is in 395 00:20:50,960 --> 00:20:54,640 Speaker 2: need of financing, and henceforth repo rates go up. Now, 396 00:20:54,680 --> 00:20:57,840 Speaker 2: what was happening on both sides of that equation. Well, 397 00:20:57,880 --> 00:20:59,800 Speaker 2: on the cash side, what you see is that dealers 398 00:20:59,800 --> 00:21:03,840 Speaker 2: to reduce their intermediation in the repo market due to 399 00:21:04,520 --> 00:21:07,919 Speaker 2: month end and especially year end balance sheet reporting dates. 400 00:21:08,280 --> 00:21:12,440 Speaker 1: Window dressing is the prefer you said it not, It's 401 00:21:12,480 --> 00:21:13,640 Speaker 1: my preferred term. 402 00:21:13,920 --> 00:21:16,600 Speaker 2: And we also see that there's big treasury settlements at 403 00:21:16,600 --> 00:21:18,159 Speaker 2: the end of the month, and there's more collateral that 404 00:21:18,240 --> 00:21:20,760 Speaker 2: needs to be financed, and so the rebo market is 405 00:21:20,840 --> 00:21:24,560 Speaker 2: just more susceptible to moving higher because of that cash 406 00:21:24,600 --> 00:21:29,920 Speaker 2: collateral dynamic that shifts on month ends. Now this links 407 00:21:30,080 --> 00:21:33,560 Speaker 2: to what happens with commercial banks and their liquidity preferences, 408 00:21:33,880 --> 00:21:37,440 Speaker 2: because commercial banks are indeed a big source of cash, 409 00:21:37,480 --> 00:21:40,440 Speaker 2: and commercial banks we saw in twenty eighteen and twenty 410 00:21:40,520 --> 00:21:43,080 Speaker 2: nineteen as the FED was doing QT and that cash 411 00:21:43,119 --> 00:21:46,439 Speaker 2: collateral balance shifted. Commercial banks were big lenders in the 412 00:21:46,480 --> 00:21:48,520 Speaker 2: cash market at that period of time. They were taking 413 00:21:48,560 --> 00:21:53,080 Speaker 2: their overnight liquidity investing in overnight treasure GC repo, which 414 00:21:53,119 --> 00:21:56,280 Speaker 2: is a close substitute, but importantly not a perfect substitute. 415 00:21:56,720 --> 00:21:59,640 Speaker 2: And we now see again that as repo rates arising, 416 00:21:59,680 --> 00:22:02,600 Speaker 2: commerce banks are choosing to lend a little bit more 417 00:22:03,040 --> 00:22:06,439 Speaker 2: in the repo market to try and keep GC rebo 418 00:22:06,680 --> 00:22:10,600 Speaker 2: in check. The question we have though, is how much 419 00:22:10,640 --> 00:22:13,439 Speaker 2: cash is there truly to keep these funding markets in 420 00:22:13,520 --> 00:22:17,520 Speaker 2: check as the cash collateral balance shifts, And will these 421 00:22:17,560 --> 00:22:20,919 Speaker 2: banks be willing to take that cash that they're sitting 422 00:22:20,960 --> 00:22:23,360 Speaker 2: on with the FED that is perfectly intra day liquid 423 00:22:23,800 --> 00:22:27,280 Speaker 2: and exchange it for T plus one liquidity for a 424 00:22:27,320 --> 00:22:31,080 Speaker 2: yield enhancement. That is the big question that we ask ourselves. 425 00:22:31,119 --> 00:22:32,639 Speaker 2: That is the question that the FED, I think is 426 00:22:32,680 --> 00:22:36,159 Speaker 2: asking themselves, and that will ultimately be what we believe 427 00:22:36,280 --> 00:22:38,919 Speaker 2: is the driver of how far they can actually shrink 428 00:22:39,040 --> 00:22:39,840 Speaker 2: the balance. 429 00:22:39,480 --> 00:22:43,199 Speaker 1: Sheet out of curiosity. Do you see any interplay with 430 00:22:43,960 --> 00:22:50,560 Speaker 1: the recent changes to the BTFP, the Emergency bank funding program, 431 00:22:50,680 --> 00:22:53,760 Speaker 1: and Big Bank's willingness to fund REPO. 432 00:22:54,040 --> 00:22:56,159 Speaker 2: It's too soon, I think to tell, but in theory 433 00:22:56,160 --> 00:22:58,720 Speaker 2: you can imagine that there would be a connection because 434 00:22:58,760 --> 00:23:00,960 Speaker 2: the BTFP, for as long as it was going to 435 00:23:00,960 --> 00:23:04,200 Speaker 2: be available for new loans, served as a cheap, low 436 00:23:04,280 --> 00:23:07,879 Speaker 2: cost source of additional liquidity that banks might want. That 437 00:23:07,880 --> 00:23:11,639 Speaker 2: the liquidity was available on very favorable terms, not just price, 438 00:23:11,720 --> 00:23:13,760 Speaker 2: but the facility was set up such that it funded 439 00:23:14,160 --> 00:23:18,440 Speaker 2: treasuries or agency paper at par, not market value, and 440 00:23:18,480 --> 00:23:21,280 Speaker 2: that's a big difference when you've got overnight rates that 441 00:23:21,320 --> 00:23:24,679 Speaker 2: are still above five percent. So the fact that BTFP 442 00:23:25,080 --> 00:23:27,879 Speaker 2: is well, the terms have now changed, and the facility 443 00:23:28,040 --> 00:23:31,040 Speaker 2: we know will now be going away in early to 444 00:23:31,080 --> 00:23:34,639 Speaker 2: mid March, that perhaps means that banks cannot rely on 445 00:23:34,680 --> 00:23:37,080 Speaker 2: that as another source of very favorable liquidity, and all 446 00:23:37,119 --> 00:23:40,240 Speaker 2: else equal for prudent liquidity management purposes might want to 447 00:23:40,280 --> 00:24:09,119 Speaker 2: hold more cash as opposed to less. 448 00:23:57,760 --> 00:24:00,879 Speaker 3: The FED balance sheet. You know, I didn't talk about well, 449 00:24:00,880 --> 00:24:02,159 Speaker 3: I don't know. I was gonna say. I was going 450 00:24:02,200 --> 00:24:04,120 Speaker 3: to say we didn't talk about it much before two 451 00:24:04,119 --> 00:24:05,919 Speaker 3: thousand and eight. But the truth of the matter is 452 00:24:05,960 --> 00:24:08,680 Speaker 3: I wasn't even in journalism before two thousand and eight, 453 00:24:08,720 --> 00:24:10,240 Speaker 3: So who am I to say we didn't talk about 454 00:24:10,240 --> 00:24:12,119 Speaker 3: it much. But I do get the impression that it 455 00:24:12,200 --> 00:24:15,680 Speaker 3: wasn't is active on people's minds. Back then, it was 456 00:24:15,720 --> 00:24:18,199 Speaker 3: pretty small. It was less than a trillion dollars. Then 457 00:24:18,240 --> 00:24:20,600 Speaker 3: the financial crisis happened. It just keeps getting bigger and bigger, 458 00:24:20,600 --> 00:24:23,240 Speaker 3: and now it's somewhere a little less than eight trillion dollars. 459 00:24:23,440 --> 00:24:25,959 Speaker 3: Is there a cost to a big balance sheet? 460 00:24:26,080 --> 00:24:26,199 Speaker 2: Like? 461 00:24:26,240 --> 00:24:27,960 Speaker 3: I get this idea that people think, like, oh, we 462 00:24:28,000 --> 00:24:29,880 Speaker 3: should normalize it, or we want to bring it down, 463 00:24:29,880 --> 00:24:32,199 Speaker 3: et cetera. But you know, you describe. There are various 464 00:24:32,400 --> 00:24:35,560 Speaker 3: reasons why large banks, for both regulatory and business reasons, 465 00:24:35,880 --> 00:24:39,520 Speaker 3: want to have ample liquid reserves. Is there some price 466 00:24:39,760 --> 00:24:43,280 Speaker 3: or some negative aspect of a large balance sheet or 467 00:24:43,400 --> 00:24:47,240 Speaker 3: is there some I guess sound reason why the FED 468 00:24:47,359 --> 00:24:50,639 Speaker 3: wants to continue to shrink it or normalize it whatever 469 00:24:50,680 --> 00:24:51,119 Speaker 3: that means. 470 00:24:51,320 --> 00:24:54,399 Speaker 2: Yes, I think there's two key reasons. The first is 471 00:24:54,440 --> 00:24:57,480 Speaker 2: perhaps a little bit fuzzier, the second is much more practical. 472 00:24:57,960 --> 00:25:00,680 Speaker 2: The first reason is that the FED, and what they say, 473 00:25:00,800 --> 00:25:04,040 Speaker 2: is that they don't want to have an outsized footprint 474 00:25:04,160 --> 00:25:07,280 Speaker 2: in financial markets. They don't want to be distorting financial 475 00:25:07,320 --> 00:25:10,960 Speaker 2: markets to the extent beyond what is absolutely necessary to 476 00:25:11,000 --> 00:25:15,560 Speaker 2: achieve their key monetary policy or financial stability objectives. So 477 00:25:15,600 --> 00:25:19,240 Speaker 2: that's one. But the second reason is much more practical, 478 00:25:19,560 --> 00:25:22,080 Speaker 2: and that is that there is a cost, a very 479 00:25:22,160 --> 00:25:25,359 Speaker 2: measurable cost to having a large balance sheet. If you 480 00:25:25,359 --> 00:25:28,200 Speaker 2: think about the Fed's assets and liabilities. On the asset side, 481 00:25:28,200 --> 00:25:31,360 Speaker 2: they pretty much have treasury securities and mortgage bonds. Those 482 00:25:31,480 --> 00:25:34,760 Speaker 2: right now are probably yielding all in somewhere in the 483 00:25:34,760 --> 00:25:36,320 Speaker 2: neighborhood of two and a half to three and a 484 00:25:36,359 --> 00:25:39,720 Speaker 2: half percent all told. But on the liability side of 485 00:25:39,760 --> 00:25:43,560 Speaker 2: the fed's balance sheet, there are two big cost items 486 00:25:43,680 --> 00:25:47,440 Speaker 2: that are there. One is the interest on reserve balances 487 00:25:47,600 --> 00:25:49,879 Speaker 2: rate that they pay to commercial banks. That rate is 488 00:25:49,880 --> 00:25:52,639 Speaker 2: currently five point four percent. And then the other is 489 00:25:52,640 --> 00:25:55,480 Speaker 2: the rate that they pay on their overnight reverse repo facility, 490 00:25:55,640 --> 00:25:58,359 Speaker 2: and that is five point three percent. And between the 491 00:25:58,400 --> 00:26:01,320 Speaker 2: two of these there is close to four trillion dollars 492 00:26:01,760 --> 00:26:03,640 Speaker 2: that is kept with the FED, and where the FED 493 00:26:03,760 --> 00:26:06,439 Speaker 2: is paying a rate that is between five point three 494 00:26:06,480 --> 00:26:09,600 Speaker 2: and five point four percent. So they are very much 495 00:26:09,760 --> 00:26:12,439 Speaker 2: paying out a higher rate on their liabilities than they 496 00:26:12,480 --> 00:26:16,240 Speaker 2: are taking in on their assets. And what that has 497 00:26:16,280 --> 00:26:21,320 Speaker 2: resulted in is that the FED is actually insolvent. They 498 00:26:21,359 --> 00:26:25,920 Speaker 2: are running negative NIM and they have seen their capital 499 00:26:26,240 --> 00:26:29,760 Speaker 2: essentially move into negative territory. And it's over one hundred 500 00:26:29,840 --> 00:26:31,439 Speaker 2: billion now. I think the number is close to one 501 00:26:31,480 --> 00:26:33,520 Speaker 2: hundred earth one hundred and thirty to one hundred and 502 00:26:33,520 --> 00:26:34,080 Speaker 2: forty billion. 503 00:26:34,280 --> 00:26:36,680 Speaker 1: I can't bring myself to do a drum roll, Joe, 504 00:26:36,960 --> 00:26:40,480 Speaker 1: but I broke that story. Yeah, when they first when 505 00:26:40,520 --> 00:26:45,080 Speaker 1: they first went negative, I think it was late. Now 506 00:26:45,160 --> 00:26:47,240 Speaker 1: I can't I can't do drum rolls. I can't. 507 00:26:47,440 --> 00:26:50,360 Speaker 2: So the FED calls this a deferred asset, and essentially 508 00:26:50,359 --> 00:26:54,080 Speaker 2: what it represents is the amount that they will withhold 509 00:26:54,240 --> 00:26:57,959 Speaker 2: in the future to repay the negative equity position that 510 00:26:58,000 --> 00:27:01,720 Speaker 2: they have got themselves in. They will take any excess 511 00:27:01,720 --> 00:27:04,200 Speaker 2: income on their securities portfolio and remit that to the 512 00:27:04,280 --> 00:27:07,960 Speaker 2: US Treasury. Remember when rates were really low or near zero, 513 00:27:08,240 --> 00:27:11,199 Speaker 2: but the curve was somewhat upward sloping, the FED was 514 00:27:11,240 --> 00:27:14,840 Speaker 2: buying treasuries and mortgages. They were essentially taking in I 515 00:27:14,840 --> 00:27:16,560 Speaker 2: don't even know if it was a one percent coupon 516 00:27:16,640 --> 00:27:20,560 Speaker 2: at the time, and they were paying out functionally zero 517 00:27:20,840 --> 00:27:23,919 Speaker 2: on their liabilities. And they were in that position for 518 00:27:23,920 --> 00:27:26,879 Speaker 2: a very long time, and they used to generate tens 519 00:27:26,920 --> 00:27:30,080 Speaker 2: of billions of dollars for the US taxpayer, something like 520 00:27:30,119 --> 00:27:32,720 Speaker 2: seventy billion eighty billion dollars that they would remit to 521 00:27:32,760 --> 00:27:35,919 Speaker 2: the US Treasury. Well now they're not doing that, and 522 00:27:35,960 --> 00:27:39,960 Speaker 2: they're essentially accounting for this by claiming an IOU that 523 00:27:40,000 --> 00:27:43,479 Speaker 2: they will repay to themselves to cover these losses before 524 00:27:43,520 --> 00:27:46,119 Speaker 2: they start those remittances to the US Treasury. And what 525 00:27:46,160 --> 00:27:49,880 Speaker 2: this means is that the inflows to the US Treasury 526 00:27:49,920 --> 00:27:52,080 Speaker 2: are lower than the otherwise would have been. So this 527 00:27:52,160 --> 00:27:56,720 Speaker 2: is a very real and measurable cost. Now what's surprising, 528 00:27:56,920 --> 00:27:59,240 Speaker 2: at least to me, is that this has not been 529 00:27:59,240 --> 00:28:03,320 Speaker 2: a political issue whatsoever in the US when you think about, well, 530 00:28:03,320 --> 00:28:05,359 Speaker 2: who is the FED accountable to. They're accountable to the 531 00:28:05,400 --> 00:28:09,119 Speaker 2: American public, and who is designed to maintain that accountability. 532 00:28:09,119 --> 00:28:12,400 Speaker 2: It's Congress. Yet when the FED share goes and testifies 533 00:28:12,440 --> 00:28:15,000 Speaker 2: in front of Congress, this issue never comes up. And 534 00:28:15,040 --> 00:28:17,959 Speaker 2: it's very surprising to me that it has not come up. 535 00:28:18,000 --> 00:28:21,119 Speaker 2: And for what it's worth, this issue in the US 536 00:28:21,520 --> 00:28:25,800 Speaker 2: is not unique. It's also an issue in Europe in 537 00:28:25,840 --> 00:28:31,000 Speaker 2: the UK, but this issue is of much more prominence 538 00:28:31,119 --> 00:28:34,240 Speaker 2: in those jurisdictions because in the case of the euro Area, 539 00:28:34,640 --> 00:28:37,479 Speaker 2: they literally have to figure out, well, which government is 540 00:28:37,560 --> 00:28:42,440 Speaker 2: going to pay for the negative equity on the ECB's 541 00:28:42,480 --> 00:28:46,160 Speaker 2: balance sheet, And in the UK there is quite literally 542 00:28:46,560 --> 00:28:50,040 Speaker 2: a regime by which they have to raise taxes in 543 00:28:50,120 --> 00:28:52,840 Speaker 2: order to pay for the negative equity at the Bank 544 00:28:52,880 --> 00:28:55,520 Speaker 2: of England. In the US, we just you know, it 545 00:28:55,600 --> 00:28:58,360 Speaker 2: sort of sits there and it's thought that it'll be 546 00:28:58,400 --> 00:29:01,280 Speaker 2: paid back over time, and it is not an issue 547 00:29:01,280 --> 00:29:04,920 Speaker 2: of prominence. If it were to be an issue of prominence, 548 00:29:04,960 --> 00:29:08,479 Speaker 2: if it were to be a larger political issue, then 549 00:29:08,600 --> 00:29:10,520 Speaker 2: I would think that the FED would have a greater 550 00:29:10,600 --> 00:29:12,800 Speaker 2: incentive to try and shrink the balance sheet, or at 551 00:29:12,840 --> 00:29:15,000 Speaker 2: least to try and get themselves out of this negative 552 00:29:15,440 --> 00:29:19,080 Speaker 2: equity position faster, certainly negative nim position that they are 553 00:29:19,080 --> 00:29:22,680 Speaker 2: in faster. So again, are their costs, Yes, there are. 554 00:29:22,840 --> 00:29:25,360 Speaker 2: They are only real costs if let's say we care 555 00:29:25,920 --> 00:29:30,600 Speaker 2: about them, we collectively as a electorate in the US. 556 00:29:31,320 --> 00:29:34,960 Speaker 2: But that issue, at least in my perception, is very 557 00:29:35,000 --> 00:29:38,760 Speaker 2: low on the list of congressional priorities, in the list 558 00:29:38,800 --> 00:29:40,360 Speaker 2: of voting priorities in the US. 559 00:29:40,760 --> 00:29:44,360 Speaker 1: This is such an interesting topic to me. And again, 560 00:29:44,440 --> 00:29:47,840 Speaker 1: in addition to writing when the FED finally went into 561 00:29:47,840 --> 00:29:50,240 Speaker 1: a negative capital position in late twenty twenty two, I 562 00:29:50,240 --> 00:29:52,840 Speaker 1: had a peace out in March of twenty twenty two 563 00:29:53,400 --> 00:29:55,520 Speaker 1: and the title of it was why the FED losing 564 00:29:55,560 --> 00:29:59,600 Speaker 1: money might matter for monetary policy, Because, as you say, Mark, 565 00:29:59,800 --> 00:30:03,480 Speaker 1: the conventional wisdom is that, like, it doesn't really matter, 566 00:30:04,080 --> 00:30:07,360 Speaker 1: it's all accounting. Maybe it'll be a bit embarrassing if 567 00:30:07,480 --> 00:30:10,240 Speaker 1: Powell has to testify before Congress and someone is like, oh, 568 00:30:10,240 --> 00:30:13,920 Speaker 1: you're losing money, But it does seem to me like 569 00:30:14,480 --> 00:30:17,000 Speaker 1: you could get a situation where the central Bank does 570 00:30:17,080 --> 00:30:21,240 Speaker 1: have to adjust something like QT in order to take 571 00:30:21,240 --> 00:30:24,520 Speaker 1: into account ongoing interest rate expenses, and that could actually 572 00:30:24,600 --> 00:30:27,960 Speaker 1: affect policy sort of at the margins, it feels like 573 00:30:28,800 --> 00:30:29,240 Speaker 1: I agree. 574 00:30:29,280 --> 00:30:31,360 Speaker 2: At the margins, know the Feed is not going to 575 00:30:31,480 --> 00:30:35,840 Speaker 2: let this dictate their core objective of maximum employment and 576 00:30:35,840 --> 00:30:38,680 Speaker 2: price stability, but if they were getting a lot of 577 00:30:38,760 --> 00:30:40,880 Speaker 2: heat for it, it would mean that they want to 578 00:30:40,920 --> 00:30:43,960 Speaker 2: try and shrink the balance sheet, arguably by more than 579 00:30:43,960 --> 00:30:46,560 Speaker 2: they otherwise would have and be less accommodative for the 580 00:30:46,640 --> 00:30:49,920 Speaker 2: bank demand for liquidity that we were discussing earlier, or 581 00:30:50,120 --> 00:30:53,520 Speaker 2: that they might try and move the prices that they 582 00:30:53,560 --> 00:30:57,560 Speaker 2: pay on the core liabilities that they have again, cash 583 00:30:57,600 --> 00:31:00,520 Speaker 2: that's held by commercial banks or overnight investments money funds 584 00:31:00,560 --> 00:31:02,880 Speaker 2: are making with the Fed, they might try and move 585 00:31:02,960 --> 00:31:06,920 Speaker 2: those lower. All e'll SQL and it's perhaps not an 586 00:31:06,960 --> 00:31:10,280 Speaker 2: issue if it's not top of mind for let's say, 587 00:31:10,280 --> 00:31:12,720 Speaker 2: those who hold a FED accountable, but it certainly could 588 00:31:12,800 --> 00:31:15,600 Speaker 2: be if those dynamics do change. 589 00:31:16,080 --> 00:31:20,200 Speaker 3: Under current political dynamics, which is Congress probably doesn't care 590 00:31:20,320 --> 00:31:22,600 Speaker 3: that much because you know, it's probably not going to 591 00:31:22,600 --> 00:31:24,720 Speaker 3: be a big, you know, voting issue in November would 592 00:31:24,720 --> 00:31:27,920 Speaker 3: be my guest. But under current dynamics of the degree 593 00:31:27,960 --> 00:31:30,720 Speaker 3: to which people care and everything, what is your forecast 594 00:31:30,920 --> 00:31:32,800 Speaker 3: for where the balance she goes here? Yeah, everything we've 595 00:31:32,800 --> 00:31:33,280 Speaker 3: talked about. 596 00:31:33,320 --> 00:31:35,960 Speaker 2: So we have an out of consensus view and that 597 00:31:36,080 --> 00:31:38,520 Speaker 2: we think that the FED is going to be slowing 598 00:31:38,600 --> 00:31:42,600 Speaker 2: QT a little bit earlier than expected and likely wrapping 599 00:31:42,720 --> 00:31:46,080 Speaker 2: up by let's say, mid to late summer the QT 600 00:31:46,240 --> 00:31:49,680 Speaker 2: program that would see the Fed's balance sheet likely in 601 00:31:49,680 --> 00:31:52,600 Speaker 2: the neighborhood of seven and a half trillion. It's about 602 00:31:52,600 --> 00:31:56,959 Speaker 2: seven points seventy five trillion right now, And the reason 603 00:31:57,040 --> 00:31:59,480 Speaker 2: for that is that we think that they will be 604 00:31:59,720 --> 00:32:04,000 Speaker 2: a bit more accommodative and willing to provide the necessary 605 00:32:04,080 --> 00:32:08,040 Speaker 2: liquidity that we perceive that commercial banks are demanding. Now. 606 00:32:08,360 --> 00:32:10,520 Speaker 2: The FED is they think about how far they want 607 00:32:10,560 --> 00:32:13,160 Speaker 2: to push QT has to be mindful of the lessons 608 00:32:13,200 --> 00:32:15,960 Speaker 2: that they learned in twenty nineteen. Banks were demanding more 609 00:32:16,000 --> 00:32:18,000 Speaker 2: liquidity than they thought. They shrunk the balanceet by too 610 00:32:18,080 --> 00:32:21,760 Speaker 2: much and they cause that unnecessary rebowl market volatility and 611 00:32:21,960 --> 00:32:26,040 Speaker 2: what they are likely debating today and perhaps tomorrow. Is 612 00:32:26,120 --> 00:32:27,920 Speaker 2: how far do they want to push it this time? 613 00:32:28,360 --> 00:32:30,640 Speaker 2: When might they slow down QT? And what are the 614 00:32:30,680 --> 00:32:33,200 Speaker 2: considerations that they will be looking for? And we do 615 00:32:33,280 --> 00:32:36,800 Speaker 2: believe that this very technical facility that they have set up, 616 00:32:36,880 --> 00:32:39,920 Speaker 2: called the Overnight Reverse Repo Facility, which is again a 617 00:32:39,960 --> 00:32:43,560 Speaker 2: facility whereby primarily money market mutual funds can invest cash 618 00:32:43,600 --> 00:32:46,280 Speaker 2: overnight with the Fed on a fully collateralized basis, mostly 619 00:32:46,280 --> 00:32:49,960 Speaker 2: by treasuries. They're asking themselves, well, when might they slow 620 00:32:50,040 --> 00:32:53,840 Speaker 2: QT in relation to how utilization of that facility is evolving. 621 00:32:54,400 --> 00:32:57,160 Speaker 2: And we do think that this is really important because 622 00:32:57,640 --> 00:33:00,760 Speaker 2: we believe that as long as there is excess cash 623 00:33:00,800 --> 00:33:03,080 Speaker 2: that money market mutual funds are choosing to invest with 624 00:33:03,160 --> 00:33:05,320 Speaker 2: the Fed on an overnight basis, as long as those 625 00:33:05,360 --> 00:33:08,200 Speaker 2: balances are positive, we think that there is clearly excess 626 00:33:08,200 --> 00:33:11,280 Speaker 2: liquidity in the system. If there's excess liquidity, then the 627 00:33:11,280 --> 00:33:14,280 Speaker 2: FED should feel comfortable proceding full steam ahead with QT. 628 00:33:15,120 --> 00:33:19,600 Speaker 2: But once those balances are exhausted or very low, then 629 00:33:19,640 --> 00:33:21,720 Speaker 2: the Fed might want to think about slowing things down. 630 00:33:21,800 --> 00:33:23,720 Speaker 2: This was an argument that we heard earlier this month 631 00:33:23,760 --> 00:33:27,560 Speaker 2: from Dallas FED President Lori Logan. She suggested that she 632 00:33:27,680 --> 00:33:31,880 Speaker 2: would propose slowing QT once overnight RP balances were low, 633 00:33:32,240 --> 00:33:36,600 Speaker 2: now very ambiguous. At low level, we think that that 634 00:33:36,680 --> 00:33:38,720 Speaker 2: means balances that are two hundred to two hundred and 635 00:33:38,720 --> 00:33:41,440 Speaker 2: fifty billion, but we don't really know for sure. So 636 00:33:41,520 --> 00:33:44,120 Speaker 2: she wants to slow down once those balances get low, 637 00:33:44,280 --> 00:33:47,640 Speaker 2: because she wants to proceed more cautiously thereafter and ensure 638 00:33:47,640 --> 00:33:50,560 Speaker 2: that the FED doesn't inavertently withdraw too much liquidity from 639 00:33:50,600 --> 00:33:53,360 Speaker 2: the system. Again, she wants to accommodate, or so it 640 00:33:53,400 --> 00:33:57,360 Speaker 2: seems that demand that commercial banks have to hold liquidity 641 00:33:57,760 --> 00:33:59,920 Speaker 2: and will be using the overnight RP as perhaps the 642 00:34:00,080 --> 00:34:02,240 Speaker 2: best single indicator for the amount of excess that's in 643 00:34:02,280 --> 00:34:04,360 Speaker 2: the system. We think that that line of reasoning is very, 644 00:34:04,440 --> 00:34:05,120 Speaker 2: very sensible. 645 00:34:05,280 --> 00:34:10,200 Speaker 1: Wait, what about bank reserves, because before the overnight RRP existed, 646 00:34:10,239 --> 00:34:12,920 Speaker 1: it was always about the level of what is ample 647 00:34:13,000 --> 00:34:14,760 Speaker 1: and what is not in bank reserves. 648 00:34:15,000 --> 00:34:17,440 Speaker 2: That's right, and that's what they're really trying to solve for. 649 00:34:17,600 --> 00:34:21,560 Speaker 2: They want to move from a clearly abundant and they 650 00:34:21,640 --> 00:34:24,400 Speaker 2: use these words abundant and ample, but they don't define 651 00:34:24,440 --> 00:34:26,080 Speaker 2: them in any way, which kind of makes it, you know, 652 00:34:26,280 --> 00:34:29,040 Speaker 2: feel a little buzzy and a little unclear, but they 653 00:34:29,080 --> 00:34:32,000 Speaker 2: say that they want to move away from an abundant 654 00:34:32,160 --> 00:34:36,120 Speaker 2: regime of reserves to an ample regime of reserves. Again, 655 00:34:36,239 --> 00:34:40,239 Speaker 2: definitions are unclear what the distinction is. And I think 656 00:34:40,280 --> 00:34:42,239 Speaker 2: we can say that when money market rates were really 657 00:34:42,280 --> 00:34:45,880 Speaker 2: low and overnight RP facility utilization was very high, they 658 00:34:45,880 --> 00:34:49,080 Speaker 2: were clearly abundant. There was a bunch of excess liquidity 659 00:34:49,080 --> 00:34:52,680 Speaker 2: in the system, and the overnight RP helps proxy for that. However, 660 00:34:52,719 --> 00:34:56,200 Speaker 2: once RP is exhausted and it's been dropping very very rapidly, 661 00:34:56,800 --> 00:35:00,040 Speaker 2: once it's exhausted, then it's not so clear that you 662 00:35:00,040 --> 00:35:03,680 Speaker 2: you are in such an obviously abundant zone and you 663 00:35:03,680 --> 00:35:08,680 Speaker 2: are probably moving along the lines of from abundant to ample. 664 00:35:08,719 --> 00:35:12,080 Speaker 2: I know, it's these buzzwords, and well it. 665 00:35:12,040 --> 00:35:18,320 Speaker 1: Comes after ample, adequate, and oh that's good. Yeah, abundant, ample, adequate. 666 00:35:18,360 --> 00:35:21,200 Speaker 2: Yeah, I don't know non ample, Yeah. 667 00:35:21,000 --> 00:35:25,040 Speaker 3: I don't know adequate, an adequate reserves regime. 668 00:35:25,239 --> 00:35:29,719 Speaker 2: That's but the point here is that you don't know 669 00:35:30,120 --> 00:35:33,960 Speaker 2: if you're the FED where you are on that path, 670 00:35:34,600 --> 00:35:36,840 Speaker 2: and they don't want to push it too far. So 671 00:35:36,960 --> 00:35:39,960 Speaker 2: what's going to help them determine this money market rates? 672 00:35:40,320 --> 00:35:43,040 Speaker 2: So for where that trades within their target range, how 673 00:35:43,120 --> 00:35:46,040 Speaker 2: much cash commercial banks were sitting on a big quantity 674 00:35:46,040 --> 00:35:48,680 Speaker 2: of cash or going to be willing to invest in 675 00:35:49,040 --> 00:35:53,440 Speaker 2: funding markets in order to keep money markets stable. And 676 00:35:53,480 --> 00:35:56,399 Speaker 2: as you see money markets rise, and as you see 677 00:35:56,440 --> 00:35:59,240 Speaker 2: banks move some of the money and perhaps slow down 678 00:35:59,520 --> 00:36:02,120 Speaker 2: the movement of some of the excess cash that they 679 00:36:02,160 --> 00:36:04,600 Speaker 2: are holding, that should be a very clear indicator to 680 00:36:04,640 --> 00:36:07,040 Speaker 2: the FED that they have gone far enough and that 681 00:36:07,080 --> 00:36:09,840 Speaker 2: they should slow things down. Now, one final point that 682 00:36:09,880 --> 00:36:11,600 Speaker 2: I'd like to make on this is just that the 683 00:36:11,640 --> 00:36:14,840 Speaker 2: FED is also likely very well aware the demand for 684 00:36:14,920 --> 00:36:20,840 Speaker 2: reserves is not static. It's dynamic. It shifts with macroeconomic conditions, 685 00:36:21,120 --> 00:36:24,760 Speaker 2: and importantly, it shifts with interest rates. We talked earlier 686 00:36:24,840 --> 00:36:27,480 Speaker 2: about all of the reasons that we believe commercial banks 687 00:36:27,520 --> 00:36:31,560 Speaker 2: are demanding a higher quantity of liquidity. Today, SVB went down, 688 00:36:31,640 --> 00:36:36,640 Speaker 2: unrealized securities losses, changes in liquidity rigs past and perhaps upcoming. 689 00:36:37,400 --> 00:36:39,480 Speaker 2: But when you think about what happened with SVB, and 690 00:36:39,480 --> 00:36:42,280 Speaker 2: when you think about what happened with the unrealized securities losses, 691 00:36:42,320 --> 00:36:45,680 Speaker 2: it's really a function of interest rates. And if the 692 00:36:45,719 --> 00:36:49,520 Speaker 2: FED were too hypothetically say cut interest rates three hundred 693 00:36:49,560 --> 00:36:52,839 Speaker 2: basis points very swiftly, probably not going to but if 694 00:36:52,880 --> 00:36:56,319 Speaker 2: they were, we very strongly suspect that bank demand for 695 00:36:56,360 --> 00:36:59,719 Speaker 2: reserves and bank demand for liquidity would go down because 696 00:37:00,280 --> 00:37:03,520 Speaker 2: they would be more confident in their deposits stability. Those 697 00:37:03,640 --> 00:37:08,160 Speaker 2: uninsured deposits wouldn't run as fast because they have depositors 698 00:37:08,160 --> 00:37:12,319 Speaker 2: would have less attractive alternatives, and your unrealized losses on 699 00:37:12,400 --> 00:37:16,799 Speaker 2: your securities portfolio may completely go away if rates are 700 00:37:16,840 --> 00:37:21,520 Speaker 2: substantially lower. So the FED likely is aware that demand 701 00:37:21,560 --> 00:37:25,840 Speaker 2: for reserves is varying with macroeconomic conditions, is varying with 702 00:37:25,920 --> 00:37:29,440 Speaker 2: interest rates, and being more careful when interest rates are 703 00:37:29,520 --> 00:37:33,160 Speaker 2: high and you've been doing QT quickly seems prudent, though 704 00:37:33,600 --> 00:37:35,320 Speaker 2: you can question how long you might be able to 705 00:37:35,400 --> 00:37:38,200 Speaker 2: run QT, especially if the interest rate regime is substantially 706 00:37:38,239 --> 00:37:39,800 Speaker 2: lower than where it is today. 707 00:37:40,160 --> 00:37:43,120 Speaker 4: Yeah, it is true that I think reserves are at 708 00:37:43,160 --> 00:37:45,480 Speaker 4: something like three point four trillion dollars now, and they 709 00:37:45,520 --> 00:37:48,880 Speaker 4: were less than three trillion dollars right before the mini 710 00:37:48,880 --> 00:37:51,680 Speaker 4: banking crisis, so they do move around quite a bit. 711 00:37:52,120 --> 00:37:55,120 Speaker 1: Mark. That was amazing, Thank you so much for coming 712 00:37:55,200 --> 00:37:58,160 Speaker 1: on and sort of threading the needle between what's going 713 00:37:58,160 --> 00:38:00,560 Speaker 1: on at the banks and in bond markets with the FED. 714 00:38:00,680 --> 00:38:01,480 Speaker 1: Really appreciate it. 715 00:38:01,520 --> 00:38:02,400 Speaker 2: Thanks so much for having me. 716 00:38:02,520 --> 00:38:03,920 Speaker 3: That was great, Mark really appreciated. 717 00:38:04,040 --> 00:38:17,880 Speaker 2: Thanks you, Joe. 718 00:38:17,920 --> 00:38:21,200 Speaker 1: That was such an enjoyable conversation. Mark so clear on 719 00:38:21,239 --> 00:38:25,359 Speaker 1: a lot of these topics which other people sometimes either 720 00:38:25,440 --> 00:38:28,880 Speaker 1: seem to struggle with or obfuscate for various reasons. But 721 00:38:29,320 --> 00:38:29,879 Speaker 1: that was great. 722 00:38:30,000 --> 00:38:31,879 Speaker 3: That was great. I totally agree with that, Like, these 723 00:38:31,880 --> 00:38:34,640 Speaker 3: are topics when you get into the stuff where it's 724 00:38:34,719 --> 00:38:36,799 Speaker 3: easy to sort of get lost in the sea of 725 00:38:36,880 --> 00:38:38,880 Speaker 3: like I'm not really sure what's going on. Mark was 726 00:38:38,960 --> 00:38:41,759 Speaker 3: so clear and the way he like broke it down 727 00:38:42,280 --> 00:38:46,000 Speaker 3: so that last point, actually I thought was super interesting 728 00:38:46,480 --> 00:38:51,040 Speaker 3: about the relationship between rates policy and total demand for reserve, 729 00:38:51,400 --> 00:38:53,480 Speaker 3: which is not something I guess I had like quite 730 00:38:53,520 --> 00:38:55,480 Speaker 3: heard like put in pieces like that, but like this 731 00:38:55,640 --> 00:38:58,360 Speaker 3: idea that you know of unrealized losses are going to 732 00:38:58,440 --> 00:39:02,560 Speaker 3: fall if there's less competition for rates elsewhere, then banks 733 00:39:02,600 --> 00:39:05,799 Speaker 3: feel less of an impulse to hold overnight liquidity, like 734 00:39:06,000 --> 00:39:08,000 Speaker 3: very clear and not something that I had quite like 735 00:39:08,120 --> 00:39:08,920 Speaker 3: put together. 736 00:39:08,719 --> 00:39:09,279 Speaker 2: Quite like that. 737 00:39:09,520 --> 00:39:12,279 Speaker 1: Yeah, also makes a lot more sense why the FED 738 00:39:12,360 --> 00:39:14,920 Speaker 1: might be looking at something like the overnight RP, the 739 00:39:15,000 --> 00:39:19,440 Speaker 1: REBO for signs of liquidity versus reserves in the system. 740 00:39:20,120 --> 00:39:22,640 Speaker 1: The other thing. It just brought back to me the 741 00:39:22,719 --> 00:39:24,799 Speaker 1: sort of blast from the past when we were talking 742 00:39:24,800 --> 00:39:28,840 Speaker 1: about the FED reporting a loss. Yeah, I remember, this 743 00:39:28,960 --> 00:39:32,600 Speaker 1: is how old I am. I remember writing in twenty 744 00:39:32,680 --> 00:39:36,640 Speaker 1: eleven when the FED changed its accounting rules so that 745 00:39:36,840 --> 00:39:41,319 Speaker 1: it couldn't like actually go bankrupt. It changed it so 746 00:39:41,360 --> 00:39:43,239 Speaker 1: that like the most it could do is report a 747 00:39:43,280 --> 00:39:46,880 Speaker 1: sort of negative position on assets. I feel old. 748 00:39:47,160 --> 00:39:50,279 Speaker 3: Well, it's a good reminder actually the FED to write 749 00:39:50,280 --> 00:39:52,719 Speaker 3: its own recounting rules like these are you know, it's 750 00:39:52,760 --> 00:39:55,680 Speaker 3: like people look at the FEDS solvent or whatever. It's 751 00:39:55,880 --> 00:39:57,920 Speaker 3: who determines that, you know, to your point, And I 752 00:39:57,920 --> 00:40:00,279 Speaker 3: didn't even realize that I'd forgotten, or maybe I never 753 00:40:00,320 --> 00:40:02,960 Speaker 3: knew that in twenty eleven that the FED had changed 754 00:40:03,000 --> 00:40:05,880 Speaker 3: its accounting rules to avoid any problems. But it is 755 00:40:05,880 --> 00:40:07,520 Speaker 3: a good reminder that if you can write your own 756 00:40:07,520 --> 00:40:10,120 Speaker 3: accounting rules, that makes life easier. 757 00:40:10,239 --> 00:40:12,760 Speaker 1: Well, and I think the issue was that it wanted 758 00:40:12,800 --> 00:40:16,120 Speaker 1: to avoid a situation where if it had a loss, 759 00:40:16,200 --> 00:40:19,400 Speaker 1: it would have to go to the Treasury for capital 760 00:40:19,880 --> 00:40:22,120 Speaker 1: top up, which makes sense, and then that could be 761 00:40:22,280 --> 00:40:25,839 Speaker 1: a sort of vulnerability in terms of independence. So they 762 00:40:25,880 --> 00:40:28,000 Speaker 1: just rewrote the rules so that they didn't have to 763 00:40:28,400 --> 00:40:31,960 Speaker 1: dzps basically. Yeah, wouldn't it be nice I feel could 764 00:40:32,000 --> 00:40:35,480 Speaker 1: write our own accounting rules. Yes, anyway, we'll have to 765 00:40:35,480 --> 00:40:36,279 Speaker 1: get Mark on again. 766 00:40:36,320 --> 00:40:39,279 Speaker 3: Yeah, here's great. That was really good. I'm I'm glad 767 00:40:39,280 --> 00:40:40,000 Speaker 3: we finally had them on. 768 00:40:40,080 --> 00:40:42,480 Speaker 1: All right, and a big week for market. Yeah, lots 769 00:40:42,520 --> 00:40:45,440 Speaker 1: going on. It'll be interesting to see how everything shakes out. 770 00:40:45,480 --> 00:40:46,960 Speaker 1: But in the meantime, shall we leave it there? 771 00:40:47,040 --> 00:40:48,200 Speaker 3: Let's leave it there, all right. 772 00:40:48,239 --> 00:40:50,960 Speaker 1: This has been another episode of the All Thoughts podcast. 773 00:40:51,160 --> 00:40:54,480 Speaker 1: I'm Tracy Alloway. You can follow me at Tracy Alloway. 774 00:40:54,160 --> 00:40:56,960 Speaker 3: And I'm joll Wisenthal. You can follow me at the Stalwart. 775 00:40:57,160 --> 00:41:01,160 Speaker 3: Follow our producers Carmen Rodriguez at Carmen Army, Dashel Bennett 776 00:41:01,239 --> 00:41:04,840 Speaker 3: at Dashbot and kill Brooks at Kelbrooks. Thank you to 777 00:41:04,880 --> 00:41:07,880 Speaker 3: our producer Moses Ondam. For more Oddlots content, go to 778 00:41:07,880 --> 00:41:11,040 Speaker 3: bloomberg dot com slash odd Lots, where we publish transcripts, 779 00:41:11,680 --> 00:41:14,359 Speaker 3: blog and a weekly newsletter that Tracy and I Wright 780 00:41:14,560 --> 00:41:17,000 Speaker 3: and you could chat with fellow listeners. Twenty four to 781 00:41:17,040 --> 00:41:21,080 Speaker 3: seven in the discord discord dot gg slash odd Lots and. 782 00:41:21,040 --> 00:41:23,279 Speaker 1: If you enjoy odd Lots, if you like it when 783 00:41:23,320 --> 00:41:25,640 Speaker 1: we look at what's going on in the plumbing of 784 00:41:25,719 --> 00:41:28,880 Speaker 1: the monetary system, then please leave us a positive review 785 00:41:29,000 --> 00:41:32,160 Speaker 1: on your favorite podcast platform. And remember, if you're a 786 00:41:32,160 --> 00:41:37,160 Speaker 1: Bloomberg subscriber, you can listen to Audlots episodes completely ad free. 787 00:41:37,200 --> 00:41:39,759 Speaker 1: All you need to do is connect your Bloomberg subscription 788 00:41:40,280 --> 00:41:42,600 Speaker 1: with Apple Podcasts. Thanks for listening.