WEBVTT - Mark Cabana on the Fed, QT and Treasury Funding 0:00:10.680 --> 0:00:14.000 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.080 --> 0:00:17.400 I'm Tracy Allaway and I'm Joe Wisenthal. Joe, it's a 0:00:17.440 --> 0:00:17.959 busy week. 0:00:19.520 --> 0:00:20.360 It is a busy week. 0:00:20.400 --> 0:00:21.840 It sort of snuck up on me. You know, I 0:00:21.880 --> 0:00:25.119 knew it was FED week, like it's also jobs week. 0:00:25.720 --> 0:00:28.320 It's also and I'm not even sure like the degree 0:00:28.320 --> 0:00:31.760 to which it matters, quarterly refunding week sort of controversial. 0:00:31.880 --> 0:00:32.720 There's a lot going on. 0:00:33.120 --> 0:00:35.120 I got tipped off to the fact it was quarterly 0:00:35.159 --> 0:00:38.440 refunding week when everyone started talking about deficits. On Monday, 0:00:38.760 --> 0:00:41.440 you got the estimates of borrowing needs everyone. That's the 0:00:41.520 --> 0:00:45.000 day suddenly everyone becomes really worried about the credit worthiness 0:00:45.920 --> 0:00:47.720 the future United States of America. 0:00:47.960 --> 0:00:51.080 There's this theory that's going around. It's kind of controversial. 0:00:51.120 --> 0:00:53.519 I see it on Twitter sometimes that like this is 0:00:53.640 --> 0:00:56.840 like really important for markets that like some mix of 0:00:56.920 --> 0:00:59.959 bills and bonds and how much really matters. I don't really, 0:01:00.120 --> 0:01:02.480 you know, I'm like sort of like skeptical, but maybe 0:01:02.520 --> 0:01:04.800 there's something to that. But you know, a lot of 0:01:04.840 --> 0:01:08.000 moving parts right now, and of course it is FED week. 0:01:08.040 --> 0:01:11.520 I don't think anyone expects a rate cut but I 0:01:11.560 --> 0:01:15.360 think the expectation is some sort of like maybe declaration 0:01:15.520 --> 0:01:19.400 of victory and which can then be used to set 0:01:19.480 --> 0:01:21.000 up the beginning of the cutting cycle. 0:01:21.200 --> 0:01:23.959 Well, it's interesting you mentioned this theory about it having 0:01:23.959 --> 0:01:26.399 a potential impact on markets, because, of course the other 0:01:26.480 --> 0:01:29.920 thing that we expect the FED to discuss this week 0:01:30.200 --> 0:01:34.080 is quantitative tightening, so the shrinking of the balance sheet. 0:01:34.120 --> 0:01:36.800 And I find this is the thing that gets people 0:01:36.920 --> 0:01:39.720 really riled up, the idea that you know, stocks are 0:01:39.800 --> 0:01:43.320 up because of central bank liquidity and once QT begins, 0:01:43.400 --> 0:01:45.959 it's all going to wash away and stocks are going 0:01:46.040 --> 0:01:49.600 to fall. Of course, we haven't seen that, but we're 0:01:49.640 --> 0:01:52.760 still waiting on a lot of additional info about the size, 0:01:52.840 --> 0:01:55.880 the shape, the speed of QT, and there's a lot 0:01:55.920 --> 0:01:58.920 of discussion over whether or not that could change. And 0:01:58.960 --> 0:02:01.200 I should just say the meaning is tomorrow. But I 0:02:01.200 --> 0:02:02.840 don't think we're going to get a lot of detail 0:02:02.960 --> 0:02:06.240 on QT until the minutes actually come out in February. 0:02:06.280 --> 0:02:09.079 But the point is there is loads to discuss. 0:02:09.360 --> 0:02:11.280 Yeah, totally, you know. And the one thing I'll say 0:02:11.320 --> 0:02:14.000 to on the balance sheet, I'll say two things. One is, 0:02:14.400 --> 0:02:16.000 for a long time, it was just the story the 0:02:16.040 --> 0:02:18.480 FED is pumping money into the markets, and as soon 0:02:18.520 --> 0:02:21.360 as the balance sheet starts to shrink, then that's going 0:02:21.400 --> 0:02:24.040 to be bad for risk assets. That, in my opinion, 0:02:24.080 --> 0:02:27.400 has now officially been disproven because the balance sheet has 0:02:27.400 --> 0:02:30.000 been shrinking basically since the middle of twenty twenty two 0:02:30.360 --> 0:02:33.160 and stocks are at all time high. So that's over 0:02:33.280 --> 0:02:35.800 that story. It's a thesis is broken in my opinion. 0:02:35.840 --> 0:02:38.840 But what it means for banks, what it means for 0:02:38.919 --> 0:02:42.360 bank liquidity, how far they can shrink it before it 0:02:42.440 --> 0:02:45.079 creates problems such as what we talked about I think 0:02:45.120 --> 0:02:48.560 it was in twenty nineteen. This still matters quite a 0:02:48.600 --> 0:02:51.960 bit and they're still interesting policy questions related to that. 0:02:52.320 --> 0:02:56.519 Absolutely, So who better to discuss all of these issues 0:02:56.960 --> 0:03:00.959 than Mark Cabana, rates strategist over at Bank of America. Mark, 0:03:01.000 --> 0:03:02.440 thank you so much for coming on the show. 0:03:02.520 --> 0:03:03.240 Thanks for having me. 0:03:03.639 --> 0:03:07.480 We are a longtime fans of your work, and it's 0:03:07.600 --> 0:03:09.080 kind of a treat for us that we could do 0:03:09.160 --> 0:03:11.880 this and release the episode on the day of the 0:03:11.919 --> 0:03:14.440 FED meeting, So we're recording it just the day before, 0:03:14.800 --> 0:03:16.840 so we're going to get all your thoughts on what's 0:03:16.880 --> 0:03:19.920 going on at the moment. But with your rates hat on. 0:03:20.639 --> 0:03:22.720 When you look at a week like this, when you 0:03:22.800 --> 0:03:25.400 have the QRA, you have jobs, you have the Fed, 0:03:26.080 --> 0:03:28.720 what are you most interested in? How are you weighing 0:03:28.760 --> 0:03:29.720 those different events? 0:03:30.040 --> 0:03:32.200 Sure? Well, thanks for having me. I'm also a big fan, 0:03:32.320 --> 0:03:34.320 so it's a real thrill to be here. Thank you. 0:03:34.639 --> 0:03:36.720 So when we think about the rates outlook, we think 0:03:36.800 --> 0:03:39.440 that the expected path of the overnight rate is really 0:03:39.480 --> 0:03:42.240 the most important determinant of where rates go. Henceforth, the 0:03:42.240 --> 0:03:45.280 Fed is clearly the most important consideration for us this week. 0:03:45.960 --> 0:03:48.520 The payroll report and other date of this week will 0:03:48.520 --> 0:03:51.760 inform that and then still important, but perhaps secondary, is 0:03:51.760 --> 0:03:54.560 the quarterly refunding from the Treasury that supply announcement. Though 0:03:54.600 --> 0:03:57.640 I agree with Joe, it has certainly been a focus 0:03:57.760 --> 0:04:00.560 in markets, and probably much more so than the Treasury 0:04:00.600 --> 0:04:03.480 ever would have wanted. And that's really because they've surprised 0:04:03.480 --> 0:04:05.520 the market with the last two refundings. 0:04:05.600 --> 0:04:08.040 Oh that's right, because it wasn't it the August refunding 0:04:08.040 --> 0:04:11.960 announcement that kicked off that initial big surge in bond yields, 0:04:11.960 --> 0:04:13.600 and then it was the November one that kind of 0:04:13.600 --> 0:04:14.400 calmed things down. 0:04:14.640 --> 0:04:17.880 So yes, that's generally right. So they surprised by issuing 0:04:18.120 --> 0:04:21.200 more longer dated coupons in the August refunding. They then 0:04:21.240 --> 0:04:24.400 surprised by issuing fewer long dated coupons in the November 0:04:24.400 --> 0:04:27.719 of funding, and this was seen by the market as 0:04:27.760 --> 0:04:31.400 a factor that was a meaningful driver of where term 0:04:31.480 --> 0:04:34.080 premium was going. Now, I'm using air quotes as I 0:04:34.120 --> 0:04:36.280 say that. I know your listeners can't see the air quotes, 0:04:36.920 --> 0:04:38.880 but that is because the term premium is sort of 0:04:38.880 --> 0:04:42.880 this catch all, unexplained factor, at least by certain FED models, 0:04:43.279 --> 0:04:45.479 and I think one can view term premium with a 0:04:45.480 --> 0:04:49.040 healthy dose of skepticism. But nevertheless, the market perceived that 0:04:49.080 --> 0:04:53.040 those supply announcements were big drivers of movements in term premium. 0:04:53.480 --> 0:04:58.080 By the way, for listeners, Tracy, that was a minute ago. 0:04:58.160 --> 0:05:00.800 I was drum rolling that sound because I always love 0:05:01.040 --> 0:05:05.280 when eminent guests confirm my biases. So nothing feels better 0:05:05.320 --> 0:05:09.839 than that. Setting aside market perception in your own work, 0:05:10.600 --> 0:05:13.920 how important was the mix? So I guess there's two elements. 0:05:14.240 --> 0:05:17.480 Just the total size of the borrowing each quarter, which 0:05:17.520 --> 0:05:20.599 is just a sort of economic reality that is just 0:05:20.720 --> 0:05:23.600 you know, the gap between expenditures and the amount the 0:05:23.640 --> 0:05:26.360 government brings into taxes, and then there is okay, there's 0:05:26.360 --> 0:05:28.560 that mix that you described, how much is the Treasury 0:05:28.600 --> 0:05:30.720 going to issue at the long end versus the short end? 0:05:30.960 --> 0:05:33.719 How important are these things too, setting aside what the 0:05:33.720 --> 0:05:37.120 market perceives or even what the market did, like what 0:05:37.240 --> 0:05:39.719 when you see these announcements, like what are you looking for? 0:05:39.760 --> 0:05:40.560 And how significant? 0:05:41.160 --> 0:05:43.960 So they certainly matter in terms of the relative mix 0:05:43.960 --> 0:05:45.360 of what treasure is going to issue and how the 0:05:45.400 --> 0:05:47.120 private sector is going to take that down, But in 0:05:47.200 --> 0:05:49.800 terms of determining the overall direction of bond yields, we 0:05:49.800 --> 0:05:52.880 think that they are secondary important, but secondary, and what's 0:05:52.880 --> 0:05:58.080 more important is macroeconomic information, growth, inflation, jobs, et cetera, 0:05:58.440 --> 0:06:01.000 and how that's expected to impact the overall path of 0:06:01.440 --> 0:06:03.760 the FED. And what we saw really in the third 0:06:03.839 --> 0:06:06.640 quarter was, yes, you did get a larger than expected 0:06:06.680 --> 0:06:09.120 supply announcement from the Treasury, but you also had nominal 0:06:09.160 --> 0:06:11.960 GDP that was running at about five percent real nine 0:06:12.000 --> 0:06:16.680 percent nominal that we think was the much larger driver 0:06:16.960 --> 0:06:20.360 of the movement in rates. Treasury supply announcement didn't help, 0:06:20.520 --> 0:06:23.480 but again we think that the sharp upward moving rates 0:06:23.520 --> 0:06:26.120 was largely driven by better data, and conversely, in the 0:06:26.120 --> 0:06:29.800 fourth quarter data moderated to some extent, the Fed turned 0:06:29.839 --> 0:06:32.640 more dubvish. The Treasury surprise to the downside on supply, 0:06:32.760 --> 0:06:34.880 and that helped reverse some of the big move that 0:06:34.920 --> 0:06:38.799 we saw in late summer early fall. So these supply 0:06:38.800 --> 0:06:41.920 announcements from Treasury, they do matter. They influence market perception. 0:06:42.240 --> 0:06:45.120 They certainly matter in terms of how investors think about 0:06:45.320 --> 0:06:46.880 how much supply they're going to have to take down, 0:06:46.920 --> 0:06:49.120 how aggressive or not they are to bid, how dealers 0:06:49.160 --> 0:06:51.800 manage the inventory on their balance sheets. But generally speaking, 0:06:51.800 --> 0:06:54.200 we do think it's a secondary factor, secondary to the 0:06:54.440 --> 0:06:58.240 incoming economic data that influences the expected path policy mark. 0:06:58.360 --> 0:07:00.680 One of the other narratives that it became kind of 0:07:00.680 --> 0:07:02.960 popular over the past year or so was this idea 0:07:03.040 --> 0:07:06.640 of who is going to buy the bonds. So, you know, 0:07:06.680 --> 0:07:11.200 with inflation rising, with the deficit growing, with a lot 0:07:11.240 --> 0:07:15.520 of natural buyers potentially stepping back, maybe some geopolitical concerns 0:07:15.560 --> 0:07:18.960 mixed in there, there was this narrative that the traditional 0:07:19.000 --> 0:07:23.080 buying base of US Treasury debt wouldn't be as large 0:07:23.320 --> 0:07:26.280 as it had been previously. And yet fast forward to 0:07:26.320 --> 0:07:28.600 the end of twenty twenty three, we had bond yields 0:07:28.600 --> 0:07:31.440 on the tenure basically taking a round trip. They're a 0:07:31.480 --> 0:07:33.840 little over four percent right now. What do you think 0:07:33.880 --> 0:07:35.600 about that particular narrative. 0:07:35.920 --> 0:07:37.920 Yeah, So, the number one question that we were getting 0:07:37.960 --> 0:07:40.040 over the course of twenty twenty three is indeed, who's 0:07:40.080 --> 0:07:43.280 going to buy the bonds? And it is a challenging 0:07:43.360 --> 0:07:46.720 question to answer when you are seeing inflation surprise to 0:07:46.760 --> 0:07:49.240 the upside, when the FED is more hawkish than expected, 0:07:49.600 --> 0:07:52.880 and when bond yields are losing value. No surprise, investors 0:07:52.880 --> 0:07:55.600 don't really want to buy bonds when they're not holding 0:07:55.680 --> 0:07:58.200 their value, and as a result of that, we did 0:07:58.240 --> 0:08:01.400 see that demand weakened from a whole host of traditional 0:08:01.400 --> 0:08:04.120 investors over the course of twenty twenty three, though they 0:08:04.120 --> 0:08:07.320 did come back to some extent towards the tail end. Now, 0:08:07.320 --> 0:08:08.920 when we think about who's going to buy the bonds, 0:08:08.960 --> 0:08:13.440 we really think about maybe four or five traditional buyer bases, banks, 0:08:14.000 --> 0:08:19.600 pensions and insures, overseas investors, asset managers, and then the FED, 0:08:19.960 --> 0:08:21.800 and whether or not they are buying or selling at 0:08:21.800 --> 0:08:24.120 any particular point in time. They're obviously selling right now 0:08:24.720 --> 0:08:28.000 for those buyer bases. We really saw transformation in twenty 0:08:28.040 --> 0:08:31.240 twenty three from those who really had stepped away from 0:08:31.280 --> 0:08:34.120 the market largely in the first three quarters of the years, 0:08:34.320 --> 0:08:37.840 or some that had tried to buy tens at let's 0:08:37.840 --> 0:08:40.680 say four percent and then got burned as tens rose 0:08:40.760 --> 0:08:43.120 much more materially over the course of the year, and 0:08:43.120 --> 0:08:46.120 they had really taken a step back. But once we 0:08:46.200 --> 0:08:51.480 saw macroeconomic data, certainly inflation data, confirmed that the peak 0:08:51.480 --> 0:08:53.560 and inflation was over, that the FED was not going 0:08:53.600 --> 0:08:56.320 to be hiking much more likely next step would be cutting, 0:08:56.720 --> 0:08:59.520 we saw that demand return quite meaningfully. And we've seen 0:08:59.559 --> 0:09:03.200 that from those traditional buyer bases. Banks commercial banks have 0:09:03.240 --> 0:09:07.480 stepped into the market moderately. Pensions and insurers we see 0:09:07.520 --> 0:09:12.000 they have generated the largest amount of stripping activity. A stripping, remember, 0:09:12.040 --> 0:09:15.080 is when you separate a long term treasury security into 0:09:15.080 --> 0:09:18.760 a principal component and an interest component. They like to 0:09:18.760 --> 0:09:22.520 buy the principal components because they're essentially zero coupon bullets. 0:09:22.600 --> 0:09:25.040 After they've been stripped, they have low dollar values, they 0:09:25.080 --> 0:09:28.120 can add duration easily, and that helps them manage their 0:09:28.240 --> 0:09:32.120 overall liability mix. But that pension and insurance community, we 0:09:32.160 --> 0:09:35.040 think is stepped back a bit. Some foreign demand has 0:09:35.080 --> 0:09:37.800 re emerged, not from Japan, not from China, but from 0:09:37.840 --> 0:09:41.880 other parts of the world has emerged. And we've also 0:09:41.960 --> 0:09:45.400 seen that asset managers have been returning back to the 0:09:45.440 --> 0:09:48.760 market as yield stop rising. We're also now talking about 0:09:48.800 --> 0:09:51.960 the possibility that the FED will go from as active 0:09:52.000 --> 0:09:55.280 of a net seller through QT. They don't functionally sell 0:09:55.320 --> 0:09:58.160 into the secondary market, but they're responsible for more supply 0:09:58.280 --> 0:10:00.160 that the US Treasury in turn has to issue the 0:10:00.160 --> 0:10:03.839 private sector. And they're talking about slowing QT, and now 0:10:03.840 --> 0:10:06.199 we're wondering what if they're slowing, when might they stop? 0:10:06.600 --> 0:10:10.000 So that is an important determinant in shifting some of 0:10:10.040 --> 0:10:12.800 the supply demand dynamics in the rates market. So that's 0:10:12.800 --> 0:10:14.600 a long winded way of saying that we have seen 0:10:14.640 --> 0:10:18.840 those supply and demand dynamics shift. Really demand is returned 0:10:18.880 --> 0:10:21.760 to some extent, and we remain cautiously optimistic that that 0:10:21.800 --> 0:10:24.000 demand will persist over the course of twenty twenty four, 0:10:24.320 --> 0:10:27.320 assuming that macroeconomic data continues to play along with the 0:10:27.360 --> 0:10:30.079 broad narrative of slow moderation over time. 0:10:30.640 --> 0:10:34.320 Let's talk about quantitative tightening. You know, like I said 0:10:34.320 --> 0:10:36.439 in the beginning, there's always been like this one. I 0:10:36.440 --> 0:10:38.480 guess I would call it like Twitter macro or it's 0:10:38.520 --> 0:10:40.680 like one line goes up, another line goes up. They 0:10:40.760 --> 0:10:43.000 must be connected. And I think the idea that like 0:10:43.400 --> 0:10:46.480 balance sheet policy is some incredible driver of risk asset 0:10:46.600 --> 0:10:51.040 valuation is kind of debunked. But when we're discussing how 0:10:51.120 --> 0:10:54.000 far they will go to wind down and at what 0:10:54.160 --> 0:10:56.680 level that will be, who does that really matter for 0:10:56.800 --> 0:10:59.000 and why? Like, who are the actors in the market 0:10:59.240 --> 0:11:02.320 that for whom this is an important debate that they're having. 0:11:02.520 --> 0:11:04.800 Sure, I generally think of two or three actors for 0:11:04.840 --> 0:11:06.840 which it really matters in terms of how far the 0:11:06.880 --> 0:11:10.480 FED shrinks the balance sheet. First and foremost commercial banks, 0:11:10.800 --> 0:11:13.640 because they can be directly impacted by the amount of 0:11:13.880 --> 0:11:16.839 reserves or overnight liquidity that the FED is providing two 0:11:16.960 --> 0:11:19.440 commercial banks, or that it's available in the system that 0:11:19.480 --> 0:11:23.520 commercial banks can try and bid for. The second big 0:11:23.559 --> 0:11:27.520 actor is treasury and mortgage market participants, for whom if 0:11:27.520 --> 0:11:29.559 the FED is shrinking its balance sheet or growing its 0:11:29.559 --> 0:11:32.640 balance sheet, the total amount of private sector supply in 0:11:32.679 --> 0:11:35.599 the treasury or agency mortgage market can be directly influenced 0:11:35.640 --> 0:11:38.199 by that. And then the third cohort, and Joe, I 0:11:38.240 --> 0:11:40.040 think your comments have referred to this on a few 0:11:40.040 --> 0:11:42.719 times as sort of the broader risk asset investor. I 0:11:42.760 --> 0:11:44.839 almost think of them as the quote unquote M two 0:11:45.000 --> 0:11:48.040 equity investor, the type of equity investor who just wants 0:11:48.120 --> 0:11:50.680 to buy or sell equities based upon what's happening with 0:11:50.679 --> 0:11:53.640 the broader money supply. And this, I will tell you, 0:11:53.840 --> 0:11:56.880 is a very real cohort of the market, at least 0:11:56.880 --> 0:11:59.240 as far as the folks who reach out to us 0:11:59.640 --> 0:12:02.160 on the b A rate strategy team. We also view 0:12:02.200 --> 0:12:04.640 it with a healthy dose of skepticism. We don't believe 0:12:04.679 --> 0:12:07.760 that there is a particular clear connection between how many reserves, 0:12:07.800 --> 0:12:09.880 let's say, are in the banking system and then what's 0:12:09.880 --> 0:12:12.800 going to happen with the equity market. But that doesn't 0:12:12.800 --> 0:12:15.079 dissuade them. They look back at history and they say, well, 0:12:15.080 --> 0:12:17.320 when the FED was growing its balance sheet, risk assets 0:12:17.320 --> 0:12:19.840 did well. When they shrunk the balance sheet or reserves 0:12:19.880 --> 0:12:22.760 went down, the opposite happened. And really, what we think 0:12:22.800 --> 0:12:25.200 they are picking up on is the fact that the 0:12:25.240 --> 0:12:28.000 FED and other central banks use their balance sheets to 0:12:28.040 --> 0:12:31.800 almost reinforce the broader stances of monetary policy. So if 0:12:31.840 --> 0:12:34.040 they're growing the balance sheet, they're typically doing so because 0:12:34.040 --> 0:12:36.840 they're trying to stimulate activity lower long term borrowing costs. 0:12:37.040 --> 0:12:38.720 And if they shrink the balance sheet, they're generally trying 0:12:38.760 --> 0:12:40.640 to tighten policy and they're raising interest rates at the 0:12:40.679 --> 0:12:43.240 same time. So if you think about the balance sheet 0:12:43.240 --> 0:12:46.000 as reinforcing the broad stance of monetary policy, we think 0:12:46.040 --> 0:12:48.959 that the MT equity trading stance makes sense. But we 0:12:48.960 --> 0:12:51.800 would encourage investors not to blindly follow what happens with 0:12:51.960 --> 0:12:54.360 the balance sheet or with the reserve quantity and the 0:12:54.400 --> 0:12:57.440 system as an indicator of buying or selling risks. 0:13:12.640 --> 0:13:15.920 There's one sort of under the radar thing at the 0:13:15.920 --> 0:13:17.439 moment that I think is going to end up being 0:13:17.440 --> 0:13:19.640 a big deal in twenty twenty four, which is sort 0:13:19.679 --> 0:13:25.000 of the changes around liquidity requirements and regulation for banks 0:13:25.200 --> 0:13:29.200 and all of that happening against the broader backdrop of QT. 0:13:29.840 --> 0:13:32.120 But how do you see that playing out? Because there's 0:13:32.120 --> 0:13:34.959 a number of things here, so you know, there are 0:13:35.160 --> 0:13:39.200 the basil endgame proposals, there are LCR suggestions that maybe 0:13:39.520 --> 0:13:42.440 make those liquidity ratios get a little bit bigger. There's 0:13:42.600 --> 0:13:44.800 changes to I have to be careful here because I 0:13:44.840 --> 0:13:50.360 always end up saying bt FD, the BTFP, not by 0:13:50.559 --> 0:13:56.960 the F dick the BTFP and a few other things 0:13:56.960 --> 0:13:57.840 happening in the back end. 0:13:59.080 --> 0:14:02.160 So funny that this was a market mantra for like 0:14:02.200 --> 0:14:05.000 fifteen years, and then the FED came out with an 0:14:05.000 --> 0:14:09.080 emergency program in March twenty twenty three that sounded so similar, Like, 0:14:09.160 --> 0:14:11.319 let's just acknowledge that is very funny. I never even 0:14:11.400 --> 0:14:14.720 heard of that other acronym BTFD. You need to spend 0:14:14.920 --> 0:14:18.040 more time online, dear FED. You know, I want to 0:14:18.440 --> 0:14:19.040 look at Twitter. 0:14:19.240 --> 0:14:20.560 Okay, next day. 0:14:20.840 --> 0:14:22.760 We just acknowledge the elephant in the room. 0:14:22.880 --> 0:14:25.440 I'm glad we introduced mark to thank you. 0:14:25.480 --> 0:14:26.080 I learned something. 0:14:26.120 --> 0:14:28.000 I appreciate it all right, But it does feel like 0:14:28.240 --> 0:14:31.680 changes are coming for the banks. And banks are big 0:14:31.720 --> 0:14:35.880 buyers of things like treasury bonds and mortgage backed securities 0:14:35.880 --> 0:14:37.480 and things like that. So how do you see all 0:14:37.520 --> 0:14:38.640 of that playing out? 0:14:39.080 --> 0:14:43.600 Sure, So we do think that importantly with the recent 0:14:43.920 --> 0:14:47.160 rate hiking cycle from the FED and what we saw 0:14:47.200 --> 0:14:51.760 with SVB and some other regional banks, that commercial banks 0:14:51.760 --> 0:14:56.320 have really changed their preferences around liquidity in a meaningful way. 0:14:56.920 --> 0:15:00.280 And this we think will necessitate that the FED maintain 0:15:00.360 --> 0:15:02.960 a much larger balance sheet than perhaps they had originally 0:15:03.080 --> 0:15:07.920 envisioned to really accommodate this demand for overnight liquidity from 0:15:07.960 --> 0:15:12.520 commercial banks. And we think that commercial banks are demanding 0:15:12.680 --> 0:15:16.560 much more overnight liquidity for very rational and prudent reasons. 0:15:17.120 --> 0:15:21.200 The four factors that we typically cite include Number one, 0:15:21.520 --> 0:15:24.520 we all saw what happened with SVB, and the best 0:15:24.560 --> 0:15:27.920 antidote for that, we would argue, is holding lots of 0:15:27.960 --> 0:15:32.000 overnight liquidity. Number two, commercial banks are still sitting on 0:15:32.080 --> 0:15:37.240 fairly substantial unrealized securities losses and their treasury and mortgage portfolios. 0:15:37.240 --> 0:15:39.560 The recent rate rally has helped ameliorate that, but it 0:15:39.600 --> 0:15:42.080 hasn't gone away. And again, the best way to fight 0:15:42.160 --> 0:15:45.480 against those unrealized securities sowces is to hold cash. You 0:15:45.480 --> 0:15:48.560 can tell your shareholders or your regulators, don't worry about 0:15:48.560 --> 0:15:50.680 the two and a half percent mortgage or so that 0:15:50.760 --> 0:15:52.720 I bought. I'm never going to have to sell that 0:15:53.080 --> 0:15:57.120 for liquidity purposes. Because I'm holding onto so much overnight 0:15:57.160 --> 0:16:00.600 cash and I have so many deposits, we don't worry 0:16:00.640 --> 0:16:03.480 about those securities. We think that's very rational in this 0:16:03.560 --> 0:16:07.200 type of rate environment. Third reason that banks are holding 0:16:07.360 --> 0:16:10.880 more liquidity is because they perceive that some of the 0:16:11.080 --> 0:16:15.200 traditional rules of liquidity management have changed. And this goes 0:16:15.240 --> 0:16:18.600 into a fairly narrow corner of the funding markets, but 0:16:18.600 --> 0:16:21.080 it's very important, and it's around the role of the 0:16:21.120 --> 0:16:26.760 Federal Home Loan Banking System GSE that arguably had really 0:16:26.800 --> 0:16:31.560 shifted from its original intention to be a low cost, 0:16:31.760 --> 0:16:37.920 stable provider of funding for bank mortgage holdings, and regulators 0:16:38.080 --> 0:16:42.160 are well, they've asked, does this evolution of the home 0:16:42.160 --> 0:16:46.840 loan system make sense? They think, not necessarily, and that 0:16:46.880 --> 0:16:51.680 has really reduced the ability or willingness for banks to 0:16:51.800 --> 0:16:54.320 use the home loan system as a traditional funding source. 0:16:54.800 --> 0:16:56.920 The market calls the home loans, or at least the 0:16:56.960 --> 0:16:59.560 home loans have called themselves in the past, the lender 0:16:59.600 --> 0:17:03.920 of second to last resort, and that is now, let's say, 0:17:04.080 --> 0:17:07.119 not necessarily your second to last resort. It is lower 0:17:07.119 --> 0:17:10.520 on the priority list to be used. And then the 0:17:10.560 --> 0:17:12.960 fourth and final factor is that there is a perception, 0:17:13.040 --> 0:17:15.560 as you say, Tracy, that there will be additional liquidity 0:17:15.880 --> 0:17:19.159 rules and regulations coming down the pike, and all of 0:17:19.200 --> 0:17:23.159 those factors encourage banks to want to hold more liquidity, 0:17:23.440 --> 0:17:25.919 and the best type of liquidity in the world if 0:17:25.920 --> 0:17:29.520 you're a bank for all of these reasons, is cash 0:17:29.560 --> 0:17:32.680 at the FED. It is intra day liquid and if 0:17:32.720 --> 0:17:34.760 you need it, if you were to experience a large 0:17:34.800 --> 0:17:37.480 deposit outflow, you have it at the FED. You can 0:17:37.560 --> 0:17:40.840 get it on demand as long as FED wire is opened, 0:17:41.359 --> 0:17:45.320 and that has real value if you are a commercial bank. 0:17:45.720 --> 0:17:48.440 And as a result of that, commercial banks have been 0:17:48.640 --> 0:17:52.600 choosing to hold a lot more liquidity. They've been paying 0:17:52.680 --> 0:17:57.159 up through more elevated sources of borrowing such as large 0:17:57.200 --> 0:18:01.320 time deposits, CDs, other forms of termed at borrowing, and 0:18:01.560 --> 0:18:04.600 they have been doing that in order to hold more cash. 0:18:04.880 --> 0:18:09.520 And that indicates to us this increased preference to hold liquidity. 0:18:09.920 --> 0:18:12.120 And if that is indeed right, it's going to mean 0:18:12.119 --> 0:18:14.520 that the FED is unable to shrink its balance sheet, 0:18:14.560 --> 0:18:17.919 perhaps as far as it had originally thought. Now, the 0:18:18.000 --> 0:18:21.760 question in our minds is will the FED slow down 0:18:21.920 --> 0:18:25.920 or stop in time to accommodate this, or will they 0:18:26.080 --> 0:18:30.840 risk another funding market increase or sharp jump like we 0:18:30.880 --> 0:18:34.359 saw in September twenty nineteen. We don't know the answer 0:18:34.400 --> 0:18:36.840 to that yet, but folks like me who focus a 0:18:36.840 --> 0:18:39.920 lot on the plumbing, are very very interested in the 0:18:39.960 --> 0:18:42.720 guidance that we're going to get from Powell and others 0:18:42.760 --> 0:18:46.320 at the FED as they move forward in this debate 0:18:46.359 --> 0:18:47.200 and this discussion. 0:18:47.800 --> 0:18:51.560 Since you mentioned the plumbing, you're talking essentially about the 0:18:52.080 --> 0:18:56.719 repo madness of twenty nineteen. And then we saw a little, 0:18:57.240 --> 0:19:00.080 i don't want to say repeat, but a little glimmer 0:19:00.200 --> 0:19:03.680 of that same issue in I think it was December 0:19:04.119 --> 0:19:08.080 of last year when we saw not libor, but so 0:19:08.280 --> 0:19:12.359 for the libor replacement rate shoot up kind of unexpectedly 0:19:12.600 --> 0:19:14.840 in a few days and then come down very quickly. 0:19:15.400 --> 0:19:18.280 What was going on there in your mind? And how 0:19:18.440 --> 0:19:22.359 much of a concern should future volatility in the interbank 0:19:22.640 --> 0:19:26.400 lending market be for those at the FED and US 0:19:26.480 --> 0:19:27.560 market commentators. 0:19:27.800 --> 0:19:30.960 Sure? So, Just a quick point of fact, libor was 0:19:30.960 --> 0:19:34.000 indeed unsecured interbank funding, or at least that's what it 0:19:34.000 --> 0:19:37.879 was intended to be. So is importantly secured funding that 0:19:37.960 --> 0:19:41.320 has arguably a wider range of actors involved in that 0:19:41.480 --> 0:19:45.040 money market. Mutual funds who are lending cash in that market, 0:19:45.440 --> 0:19:48.080 hedge funds who are demanding leverage on the borrowing side 0:19:48.080 --> 0:19:50.919 in that market. So it is a fundamentally different space, 0:19:51.600 --> 0:19:53.520 but we do think that signals from money markets are 0:19:53.600 --> 0:19:58.400 very important indicators of what this demand for liquidity at 0:19:58.440 --> 0:20:01.760 commercial banks looks like and how much excess cash may 0:20:01.800 --> 0:20:06.200 be available to keep money markets in check. Now, how 0:20:06.200 --> 0:20:10.240 does this actually work. Well, here's our understanding of it. 0:20:10.800 --> 0:20:12.680 So when we think about the reboul market, we think 0:20:12.800 --> 0:20:15.280 very simply about it. It's nothing more than the relative 0:20:15.280 --> 0:20:18.040 balance of cash that is available to be invested in 0:20:18.080 --> 0:20:22.040 short term money markets and collateral that needs to be funded. Really, 0:20:22.119 --> 0:20:24.560 treasury collateral is the most frequent type of collateral that 0:20:24.600 --> 0:20:26.560 we think of, but there's a whole host of other 0:20:26.640 --> 0:20:31.080 collateral that gets funded mortgages, credit em etc. But again, 0:20:31.119 --> 0:20:32.960 we just think about it as in terms of cash 0:20:33.040 --> 0:20:37.560 and collateral. And what we saw at the end of December, 0:20:37.680 --> 0:20:40.520 also what we saw at the end of November is 0:20:40.600 --> 0:20:44.080 that we saw rebo rates spike for a period of time. 0:20:44.160 --> 0:20:46.720 In our framework, that simply indicates that there is less 0:20:46.760 --> 0:20:50.879 cash that's available to fund the collateral that is in 0:20:50.960 --> 0:20:54.640 need of financing, and henceforth repo rates go up. Now, 0:20:54.680 --> 0:20:57.840 what was happening on both sides of that equation. Well, 0:20:57.880 --> 0:20:59.800 on the cash side, what you see is that dealers 0:20:59.800 --> 0:21:03.840 to reduce their intermediation in the repo market due to 0:21:04.520 --> 0:21:07.919 month end and especially year end balance sheet reporting dates. 0:21:08.280 --> 0:21:12.440 Window dressing is the prefer you said it not, It's 0:21:12.480 --> 0:21:13.640