1 00:00:02,720 --> 00:00:07,560 Speaker 1: Bloomberg Audio Studios, podcasts, radio news. 2 00:00:07,800 --> 00:00:10,559 Speaker 2: Joe one and Joe two. I always wait, yeah, I 3 00:00:10,600 --> 00:00:13,320 Speaker 2: have to remember that. Well, you can answer whenever you want. 4 00:00:13,320 --> 00:00:15,680 Speaker 1: Okay, that sounds good, all right, I might just sit 5 00:00:15,720 --> 00:00:17,919 Speaker 1: back with this one. I might just listen to the 6 00:00:18,040 --> 00:00:20,279 Speaker 1: I might just listen to Joe's answers and then listen 7 00:00:20,320 --> 00:00:24,680 Speaker 1: to your questions, which would be better than mine. I 8 00:00:24,720 --> 00:00:25,439 Speaker 1: did a deadlist. 9 00:00:25,560 --> 00:00:29,080 Speaker 2: I'm both the most popular trader and most successful trader 10 00:00:29,280 --> 00:00:30,320 Speaker 2: at Citadel that. 11 00:00:30,480 --> 00:00:31,200 Speaker 1: Is going viral. 12 00:00:31,520 --> 00:00:32,240 Speaker 2: H barges. 13 00:00:32,400 --> 00:00:34,479 Speaker 1: This is an after school special, except I've. 14 00:00:34,360 --> 00:00:37,080 Speaker 2: Decided I'm going to base my entire personality going forward 15 00:00:37,159 --> 00:00:39,960 Speaker 2: on campaigning for a strategic pork reserve in the US. 16 00:00:40,200 --> 00:00:40,960 Speaker 1: Black goals. 17 00:00:41,040 --> 00:00:44,040 Speaker 2: These are the important questions that robots taking over the world. 18 00:00:44,120 --> 00:00:46,960 Speaker 1: No, I think that like in a couple of years, 19 00:00:47,120 --> 00:00:49,440 Speaker 1: the AI will do a really good job of making 20 00:00:49,440 --> 00:00:52,440 Speaker 1: the odd Launch podcast. One day that person will have 21 00:00:52,479 --> 00:00:53,520 Speaker 1: the mandate of Heaven. 22 00:00:53,680 --> 00:00:55,880 Speaker 2: How do I get more popular and successful? 23 00:00:56,200 --> 00:01:01,040 Speaker 1: We do have Welcome to lots More, where we catch 24 00:01:01,120 --> 00:01:02,640 Speaker 1: up with friends about what's going. 25 00:01:02,480 --> 00:01:05,440 Speaker 2: On right now, because even when Odd Lots is over, 26 00:01:05,800 --> 00:01:07,240 Speaker 2: there's always lots More. 27 00:01:07,840 --> 00:01:11,040 Speaker 1: And we really do have the perfect guest. 28 00:01:13,240 --> 00:01:16,560 Speaker 2: I think we've been lying to our listeners and our viewers. 29 00:01:16,360 --> 00:01:18,000 Speaker 1: Go on, this is intriguing. 30 00:01:18,240 --> 00:01:21,839 Speaker 2: We keep saying the FED is raising or lowering interest rates. 31 00:01:21,920 --> 00:01:23,759 Speaker 1: Yeah, oh, I like this. I see, I already see 32 00:01:23,800 --> 00:01:24,480 Speaker 1: where you're going with this. 33 00:01:24,680 --> 00:01:28,720 Speaker 2: But actually there's this whole constellation of rates, and we 34 00:01:28,720 --> 00:01:31,480 Speaker 2: will never really specify which one. 35 00:01:31,920 --> 00:01:34,959 Speaker 1: It's less of a lie, more of an omission, et cetera. 36 00:01:35,280 --> 00:01:38,840 Speaker 1: It is true, especially at the short term level, that 37 00:01:38,880 --> 00:01:41,080 Speaker 1: there are all these different rates and they sort of 38 00:01:41,080 --> 00:01:44,000 Speaker 1: get abstracted away because I guess they can be arbed 39 00:01:44,160 --> 00:01:47,280 Speaker 1: one way if there's between the two, if they ever deviate, 40 00:01:47,360 --> 00:01:50,240 Speaker 1: So the FED can influence these other rates, and obviously 41 00:01:50,320 --> 00:01:53,200 Speaker 1: generally strongly does, but there's no guarantee that all these 42 00:01:53,200 --> 00:01:55,800 Speaker 1: short term rates always converge identically. 43 00:01:55,960 --> 00:01:58,760 Speaker 2: No, And we have seen, for instance, instances where the 44 00:01:58,760 --> 00:02:02,040 Speaker 2: market rates have gone on far far outside what the 45 00:02:02,040 --> 00:02:04,840 Speaker 2: FED is actually targeting. So I should just say when 46 00:02:04,840 --> 00:02:08,040 Speaker 2: the FED raises or lowers interest rates, it does it 47 00:02:08,120 --> 00:02:11,239 Speaker 2: through well, it targets the FED funds, right, Yeah, okay, 48 00:02:11,280 --> 00:02:13,920 Speaker 2: and I think everyone has heard of that. But the 49 00:02:13,960 --> 00:02:18,320 Speaker 2: way it mechanically does it has changed over time. In fact, 50 00:02:18,360 --> 00:02:20,760 Speaker 2: it changed in a pretty big way early on in 51 00:02:20,840 --> 00:02:24,640 Speaker 2: our financial journalistic careers, so we should definitely talk about it. 52 00:02:24,960 --> 00:02:27,079 Speaker 2: Who's the guy that we call when we want to 53 00:02:27,120 --> 00:02:30,240 Speaker 2: talk money markets and mechanics of interest rates go on, 54 00:02:30,720 --> 00:02:31,679 Speaker 2: It's Joe Abatte. 55 00:02:31,840 --> 00:02:32,640 Speaker 1: I'm really excited. 56 00:02:32,800 --> 00:02:37,280 Speaker 2: So Joe has actually left Barclay's after more than twenty 57 00:02:37,320 --> 00:02:40,519 Speaker 2: eight years and he's now at SMBC NICO. He's head 58 00:02:40,520 --> 00:02:43,720 Speaker 2: of macro Strategy, so we're looking forward to hearing even 59 00:02:43,760 --> 00:02:46,480 Speaker 2: more from him. Joe talk to us about how the 60 00:02:46,520 --> 00:02:50,360 Speaker 2: actual mechanics of raising changing rates has changed over time. 61 00:02:51,040 --> 00:02:55,120 Speaker 3: So originally, the FED started with a scarce reserve regime, 62 00:02:55,320 --> 00:02:59,000 Speaker 3: and the idea was that the level of liquidity in 63 00:02:59,040 --> 00:03:02,560 Speaker 3: the system was kept a little bit short of what 64 00:03:02,639 --> 00:03:06,320 Speaker 3: banks really wanted to hold, and that created a little 65 00:03:06,360 --> 00:03:09,840 Speaker 3: bit of torque in this interbank market, the FED funds market, 66 00:03:09,880 --> 00:03:13,000 Speaker 3: and that allowed the FED to move the Fed Funds 67 00:03:13,080 --> 00:03:16,120 Speaker 3: rate to exactly where it wanted to set the target, 68 00:03:16,600 --> 00:03:19,800 Speaker 3: and the target was set at a pinpoint level of 69 00:03:20,080 --> 00:03:24,520 Speaker 3: interest rates. Over time, and certainly beginning in about two 70 00:03:24,560 --> 00:03:28,240 Speaker 3: thousand and eight, the FED shifted to a different format, 71 00:03:28,480 --> 00:03:33,120 Speaker 3: and in that format, the FED would supply an ample 72 00:03:33,320 --> 00:03:37,720 Speaker 3: or abundant level of reserves and let the Fed Funds rate, 73 00:03:38,200 --> 00:03:41,640 Speaker 3: you know, trade or at least, in this case, not 74 00:03:41,800 --> 00:03:46,720 Speaker 3: trade at some spread or band between an upper and 75 00:03:46,800 --> 00:03:49,200 Speaker 3: lower band where it set the target. And originally it 76 00:03:49,280 --> 00:03:52,720 Speaker 3: set the target range ban because it wasn't confident that 77 00:03:52,760 --> 00:03:56,240 Speaker 3: this new structure would keep the Fed funds rate close 78 00:03:56,320 --> 00:04:00,600 Speaker 3: to a pinpoint level. But if you supply an abundant 79 00:04:00,680 --> 00:04:04,400 Speaker 3: level of reserves into the system, what happens is the 80 00:04:04,440 --> 00:04:09,360 Speaker 3: Fed funds market changes fundamentally, it adapts, it adapts, and 81 00:04:09,680 --> 00:04:14,400 Speaker 3: as it adapted, what happened was banks stopped trading in 82 00:04:14,440 --> 00:04:17,440 Speaker 3: the Fed funds market. They didn't need to borrow reserves 83 00:04:17,440 --> 00:04:22,200 Speaker 3: anymore because there's because there were plenty exactly. So the 84 00:04:22,240 --> 00:04:26,680 Speaker 3: market kind of devolved into basically an interest rate arbitrage. 85 00:04:27,240 --> 00:04:30,440 Speaker 3: You have one set of borrowers and one set of lenders. 86 00:04:31,320 --> 00:04:35,000 Speaker 3: The borrowers in this market are generally non US banks 87 00:04:35,520 --> 00:04:39,480 Speaker 3: and the lenders are the home loan banks. And the 88 00:04:39,560 --> 00:04:43,080 Speaker 3: reason there's this distinction is because the home loan banks 89 00:04:43,240 --> 00:04:47,000 Speaker 3: can't earn interest on their reserve on their cash balances 90 00:04:47,000 --> 00:04:50,960 Speaker 3: at the FED, so they have an incentive to sell 91 00:04:51,000 --> 00:04:56,159 Speaker 3: their cash right into the FED funds market to non 92 00:04:56,320 --> 00:05:00,280 Speaker 3: US banks. We're simply making the spread between FED funds 93 00:05:00,480 --> 00:05:04,839 Speaker 3: an IRB and in an ample reserve IRB oh interest 94 00:05:04,880 --> 00:05:12,440 Speaker 3: on reserve reserve balances. And that spread has been very, 95 00:05:12,600 --> 00:05:16,960 Speaker 3: very stable for the last probably four years or so 96 00:05:17,320 --> 00:05:20,920 Speaker 3: at minus seven bases points because the Fed's been operating 97 00:05:20,960 --> 00:05:25,159 Speaker 3: in an abundant reserve regime. The abundant reserve regime first 98 00:05:25,200 --> 00:05:28,200 Speaker 3: came about because of QWI, right, So you expanded the 99 00:05:28,200 --> 00:05:31,560 Speaker 3: Fed's balance sheet, created all these reserves, so banks were 100 00:05:31,600 --> 00:05:33,760 Speaker 3: overstuffed with liquidity. 101 00:05:34,040 --> 00:05:36,719 Speaker 1: I'm going to ask a question that's going to sound 102 00:05:36,880 --> 00:05:39,480 Speaker 1: very negative, but it's not. It's actually I mean it 103 00:05:39,680 --> 00:05:42,240 Speaker 1: very literally because I think this might help us understand 104 00:05:42,240 --> 00:05:44,760 Speaker 1: why we're having this conversation. Who cares? 105 00:05:45,800 --> 00:05:47,159 Speaker 3: Who cares about these. 106 00:05:47,120 --> 00:05:49,000 Speaker 1: Any of this? And I do, and again I do 107 00:05:49,040 --> 00:05:51,200 Speaker 1: not mean this in the like a dismissive way. I 108 00:05:51,240 --> 00:05:54,080 Speaker 1: mean all of these things, like these short term things 109 00:05:54,080 --> 00:05:58,000 Speaker 1: that basically are equivalent, they could be away. The FED 110 00:05:58,080 --> 00:06:00,000 Speaker 1: seems to have a lot of control over these marks 111 00:06:00,120 --> 00:06:03,120 Speaker 1: gets in the end, even if it's not targeting one 112 00:06:03,200 --> 00:06:06,200 Speaker 1: or the other, the short term interest rate is basically 113 00:06:06,240 --> 00:06:08,880 Speaker 1: where the FED wants it. By any of these measures. 114 00:06:09,160 --> 00:06:11,880 Speaker 1: So literally, who cares about the plumbing? 115 00:06:12,200 --> 00:06:16,040 Speaker 3: So the reason I think care about the plumbing is 116 00:06:16,080 --> 00:06:20,480 Speaker 3: that the FED uses it to communicate its policy intentions. 117 00:06:20,560 --> 00:06:23,039 Speaker 3: So it needs some sort of barometer, some sort of 118 00:06:23,120 --> 00:06:26,120 Speaker 3: measure for the market to be able to interpret what 119 00:06:26,160 --> 00:06:31,000 Speaker 3: the Fed's intentions are. So there's a twofold implication, if 120 00:06:31,040 --> 00:06:33,919 Speaker 3: you will, for the Fed funds market. One is the 121 00:06:33,960 --> 00:06:38,160 Speaker 3: FED uses the Fed Funds rate to communicate its policy intentions, 122 00:06:38,160 --> 00:06:43,400 Speaker 3: so raising rates, lowering rates, And it uses the dot plot, 123 00:06:43,520 --> 00:06:47,760 Speaker 3: for example, defined as the FED funds rate to provide 124 00:06:47,800 --> 00:06:50,719 Speaker 3: forward guidance to tell the market how far we're going 125 00:06:50,839 --> 00:06:54,479 Speaker 3: or what we see as the endgame potentially for interest rates. 126 00:06:55,320 --> 00:06:58,400 Speaker 3: And the second element is kind of more of a 127 00:06:58,640 --> 00:07:01,679 Speaker 3: mechanical one, which you're from to is the plumbing, which 128 00:07:01,720 --> 00:07:06,679 Speaker 3: is how does the Fed's intentions get translated into bank 129 00:07:06,960 --> 00:07:12,240 Speaker 3: deposit rates, mortgage rates, etc. Right. And one way to 130 00:07:12,280 --> 00:07:16,320 Speaker 3: think about this is that all of these term interest rates, 131 00:07:16,360 --> 00:07:19,040 Speaker 3: tenure yields, et cetera. Are all a reflection of what 132 00:07:19,080 --> 00:07:23,360 Speaker 3: you're expected. Path of the Fed is right defined as 133 00:07:23,400 --> 00:07:27,320 Speaker 3: Fed funds plus some premium right to reflect the term 134 00:07:27,440 --> 00:07:30,800 Speaker 3: risk that you're taking or inflation risk, et cetera. And 135 00:07:30,840 --> 00:07:36,440 Speaker 3: therefore there's a linkage between the overnight rates, the communication 136 00:07:36,560 --> 00:07:41,520 Speaker 3: of policy, and how it's transmitted to the broader financial 137 00:07:41,560 --> 00:07:42,840 Speaker 3: market system. 138 00:07:43,400 --> 00:07:46,520 Speaker 2: I do think in terms of signaling the central bank's actions, 139 00:07:46,560 --> 00:07:48,800 Speaker 2: it is kind of funny that, you know, we're so 140 00:07:48,960 --> 00:07:51,720 Speaker 2: used to thinking of the Federal Reserve as a very 141 00:07:51,760 --> 00:07:55,400 Speaker 2: targeted institution, but when we're talking about reserves, the language 142 00:07:55,440 --> 00:07:58,720 Speaker 2: they use is like excess, abundant, yample, and there's no 143 00:07:58,840 --> 00:08:02,680 Speaker 2: hardcore definition of what those actually are. But I should 144 00:08:02,680 --> 00:08:05,200 Speaker 2: just say, the reason we were talking about this is 145 00:08:05,200 --> 00:08:07,680 Speaker 2: because everyone in money markets is talking about this right 146 00:08:07,720 --> 00:08:11,120 Speaker 2: now because Lori Logan at the Dallas FED, she did 147 00:08:11,120 --> 00:08:14,040 Speaker 2: a speech last week and a paper I think, basically 148 00:08:14,080 --> 00:08:17,680 Speaker 2: saying that the US the FED should move away from 149 00:08:17,760 --> 00:08:22,480 Speaker 2: targeting FED funds and look at some different ways of 150 00:08:22,720 --> 00:08:26,760 Speaker 2: targeting rates. Basically, was that a surprise to you when 151 00:08:26,760 --> 00:08:27,720 Speaker 2: you read the speech? 152 00:08:28,480 --> 00:08:30,040 Speaker 3: It was a little bit of a surprise, since we 153 00:08:30,080 --> 00:08:34,200 Speaker 3: didn't really think that the Fed was preparing to actually 154 00:08:34,320 --> 00:08:39,200 Speaker 3: change policy rates. But the overall reasons for why they 155 00:08:39,320 --> 00:08:41,679 Speaker 3: might have to move away from a FED funds target 156 00:08:42,160 --> 00:08:46,360 Speaker 3: are pretty well known. So again, as I described the 157 00:08:46,480 --> 00:08:50,119 Speaker 3: Fed funds market earlier. Right, you've got one set of borrowers, 158 00:08:50,440 --> 00:08:54,960 Speaker 3: one set of lenders. It's become kind of a Roman lake. Right. 159 00:08:55,120 --> 00:08:59,760 Speaker 3: The provinces around the Mediterranean Wall spoke Latin. So in 160 00:08:59,800 --> 00:09:03,040 Speaker 3: a effect, there's not a lot of activity going on 161 00:09:03,800 --> 00:09:08,120 Speaker 3: between the FED funds market or the reason to borrow, 162 00:09:08,600 --> 00:09:12,439 Speaker 3: So it just becomes a communications device. So if you 163 00:09:12,600 --> 00:09:16,640 Speaker 3: move to a different barometer, let's say a triparty repo rate, 164 00:09:16,720 --> 00:09:19,240 Speaker 3: we can go into details about what exactly that means. 165 00:09:19,280 --> 00:09:21,720 Speaker 2: So one that would be based on an active market. 166 00:09:21,600 --> 00:09:26,160 Speaker 3: Correct, you would get not only the communications element, but 167 00:09:26,200 --> 00:09:29,360 Speaker 3: you'd also get a feedback on how well the FED 168 00:09:29,440 --> 00:09:34,640 Speaker 3: is doing and managing liquidity. Now, if reserves are always abundant, 169 00:09:34,960 --> 00:09:37,800 Speaker 3: I don't really need that information, right, I know that 170 00:09:37,880 --> 00:09:41,200 Speaker 3: reserves are abundant. But if I want to run an 171 00:09:41,440 --> 00:09:45,680 Speaker 3: efficient balance sheet for the FED, in other words, one 172 00:09:45,720 --> 00:09:49,040 Speaker 3: that's not any larger than it needs to be to 173 00:09:49,120 --> 00:09:52,560 Speaker 3: control interest rates, then I have to kind of bring 174 00:09:52,679 --> 00:09:56,600 Speaker 3: down the level of reserves in the system and monitor 175 00:09:56,840 --> 00:09:59,800 Speaker 3: as I bring down the level of reserves. What's happening 176 00:09:59,800 --> 00:10:03,040 Speaker 3: with liquidity in the overall system? Is it, as you said, 177 00:10:03,120 --> 00:10:05,680 Speaker 3: is it staying within the bands or is it moving 178 00:10:05,720 --> 00:10:09,640 Speaker 3: outside those bands and creating other sorts of distortions. And 179 00:10:09,679 --> 00:10:13,560 Speaker 3: that's why I need, hopefully a market traded instrument, and 180 00:10:13,600 --> 00:10:15,959 Speaker 3: that would be in this case the repo rate. 181 00:10:16,640 --> 00:10:20,199 Speaker 1: What is the cost of running an inefficient balance sheet 182 00:10:20,320 --> 00:10:22,480 Speaker 1: or a balance sheet that has more reserves than are 183 00:10:22,559 --> 00:10:26,000 Speaker 1: theoretically necessarily? Okay, what's so bad about that? 184 00:10:26,080 --> 00:10:27,120 Speaker 2: You're very existential? 185 00:10:27,400 --> 00:10:29,480 Speaker 1: No, for real, Like I've heard this before. They want 186 00:10:29,520 --> 00:10:31,160 Speaker 1: to get it right. But like from an actual when 187 00:10:31,160 --> 00:10:33,959 Speaker 1: we think about the fed's goals, right, which is ultimately 188 00:10:34,360 --> 00:10:37,680 Speaker 1: and you describe it, it's about transmitting policy, these dual 189 00:10:37,800 --> 00:10:41,000 Speaker 1: mandids and all this stuff. What is the cost from 190 00:10:41,000 --> 00:10:45,400 Speaker 1: the Fed's purpose, It's raised on det of running having 191 00:10:45,440 --> 00:10:47,160 Speaker 1: a few extra these tokens on the system. 192 00:10:47,320 --> 00:10:49,240 Speaker 2: Why are we here, Joe Joe one? 193 00:10:49,520 --> 00:10:53,840 Speaker 1: Well, because because if we need to switch to X 194 00:10:53,960 --> 00:10:55,599 Speaker 1: because we want to get a better read on the 195 00:10:55,640 --> 00:10:58,920 Speaker 1: efficiency of our balance sheet. That implies that balance sheet 196 00:10:58,920 --> 00:11:00,320 Speaker 1: efficiency is an important thing. 197 00:11:01,240 --> 00:11:07,000 Speaker 3: So I agree with you. I'm personally not opposed to 198 00:11:07,040 --> 00:11:11,199 Speaker 3: a big balance sheet. I would argue that having plenty 199 00:11:11,240 --> 00:11:17,440 Speaker 3: of reserves in the system increases the safety of banks, right, 200 00:11:17,480 --> 00:11:21,679 Speaker 3: they have more liquidity, that particular type of liquidity is 201 00:11:21,720 --> 00:11:27,400 Speaker 3: immediately available, right, because bank reserves can be accessed immediately, 202 00:11:27,440 --> 00:11:31,720 Speaker 3: whereas monetizing treasuries requires either repoeing them, going to the 203 00:11:31,720 --> 00:11:36,640 Speaker 3: discount window or selling them in the market. So ample 204 00:11:36,800 --> 00:11:42,079 Speaker 3: is probably where you should be targeting. An inefficient balance 205 00:11:42,080 --> 00:11:45,319 Speaker 3: sheet would be one where you could argue that banks 206 00:11:45,360 --> 00:11:51,239 Speaker 3: are overstocked with reserves, and because they're overstocked with reserves, 207 00:11:52,360 --> 00:11:56,200 Speaker 3: the cost of those reserves for them is low, and 208 00:11:57,440 --> 00:12:02,160 Speaker 3: anything that's low in price, you have an incentive to 209 00:12:02,240 --> 00:12:06,439 Speaker 3: hold more than you probably need. So from an efficiency argument, 210 00:12:06,480 --> 00:12:10,120 Speaker 3: you might argue that banks, because they've been oversupplied with 211 00:12:10,160 --> 00:12:14,840 Speaker 3: bank reserves, their demand for those reserves is excessive and 212 00:12:14,880 --> 00:12:18,000 Speaker 3: they should be holding, you know, kind of more treasuries 213 00:12:18,040 --> 00:12:21,360 Speaker 3: and other assets. The other example of this is if 214 00:12:21,360 --> 00:12:25,679 Speaker 3: you have a loaded federal reserve balance sheet right during 215 00:12:25,840 --> 00:12:30,920 Speaker 3: for example, QE, right, you create other sorts of distortions 216 00:12:31,080 --> 00:12:33,840 Speaker 3: in the market. So during QE, what we saw was 217 00:12:33,880 --> 00:12:38,400 Speaker 3: that bank demand for loans or loan demand was weak, right, 218 00:12:39,000 --> 00:12:42,079 Speaker 3: and the FED was pushing all these reserves into the system. 219 00:12:42,320 --> 00:12:45,120 Speaker 3: Banks ended up with lots and lots of deposits. These 220 00:12:45,160 --> 00:12:49,480 Speaker 3: deposits were uninsured, right, and they were very rate sensitive, 221 00:12:50,080 --> 00:12:52,920 Speaker 3: so that when the FED began raising interest rates, that 222 00:12:53,040 --> 00:12:57,920 Speaker 3: cash left very quickly, as in March of twenty three. 223 00:12:59,160 --> 00:13:02,240 Speaker 3: At the same time time, the cash on their balance 224 00:13:02,240 --> 00:13:06,640 Speaker 3: sheet was crowding out their fixed amount of capital, right, 225 00:13:06,760 --> 00:13:10,360 Speaker 3: So you were basically holding more cash than you wanted 226 00:13:10,400 --> 00:13:14,080 Speaker 3: to and you were rolling it into securities because loan 227 00:13:14,120 --> 00:13:16,840 Speaker 3: demand wasn't there, and so you had a balance sheet 228 00:13:16,880 --> 00:13:20,520 Speaker 3: that became more heavily skewed toward. This is the banks 229 00:13:20,679 --> 00:13:27,800 Speaker 3: skewed toward treasuries, lots of cash, and more flight prone liabilities. 230 00:13:28,240 --> 00:13:33,240 Speaker 3: So when the Fed began raising interest rates, everything became 231 00:13:33,360 --> 00:13:35,520 Speaker 3: unglued or became more volatile. 232 00:13:36,240 --> 00:13:39,320 Speaker 2: There was also I think a populist component for a 233 00:13:39,360 --> 00:13:41,800 Speaker 2: time where people used to get upset that like the 234 00:13:41,840 --> 00:13:44,760 Speaker 2: foreign banks were earning lots of interest on their reserves 235 00:13:44,800 --> 00:13:45,400 Speaker 2: and things like that. 236 00:13:45,480 --> 00:13:50,960 Speaker 3: Do you remember I do. I actually remember even earlier 237 00:13:51,000 --> 00:13:53,800 Speaker 3: than that, where there was work done about who was 238 00:13:53,840 --> 00:13:58,040 Speaker 3: benefiting from the liquidity programs in the financial crisis, and 239 00:13:58,080 --> 00:14:01,280 Speaker 3: there were in fact some newsagents he's filing Freedom of 240 00:14:01,320 --> 00:14:05,680 Speaker 3: Information Act requests to find out exactly who used what 241 00:14:05,800 --> 00:14:07,040 Speaker 3: facility and how much. 242 00:14:20,680 --> 00:14:23,600 Speaker 2: Okay, I have to ask why the tri party rate 243 00:14:23,720 --> 00:14:28,720 Speaker 2: and not something like SOFUR the secured overnight financing rate, 244 00:14:28,760 --> 00:14:30,520 Speaker 2: which I thought, you know, that's supposed to be the 245 00:14:30,560 --> 00:14:34,480 Speaker 2: de facto benchmark money market rate, the one that replaced libor. 246 00:14:35,280 --> 00:14:35,800 Speaker 1: That's right. 247 00:14:36,080 --> 00:14:40,120 Speaker 3: I think the main distinction is because the triparty rate 248 00:14:40,280 --> 00:14:43,880 Speaker 3: or the triparty market itself, is a pure financing market. 249 00:14:44,320 --> 00:14:47,360 Speaker 3: It's the market in which the dealer community is raising 250 00:14:47,440 --> 00:14:52,480 Speaker 3: cash from cash providers like money market funds. By contrast, 251 00:14:52,680 --> 00:14:55,000 Speaker 3: SOFA is a little bit broader because it includes the 252 00:14:55,000 --> 00:14:58,400 Speaker 3: bilateral repo market. Because it includes the bilateral repo market. 253 00:14:58,800 --> 00:15:02,160 Speaker 3: That's more of a market where people are looking for 254 00:15:02,400 --> 00:15:08,440 Speaker 3: financing as well as specific q SIPs or specific treasury securities, 255 00:15:08,880 --> 00:15:11,440 Speaker 3: so they may have the left shoe, but they're looking 256 00:15:11,480 --> 00:15:16,360 Speaker 3: for the right shoe right. And because of that, you 257 00:15:16,480 --> 00:15:20,080 Speaker 3: basically have two different equilibria in the market. You have 258 00:15:20,120 --> 00:15:24,720 Speaker 3: a triparty equilibrium and then you have a SOFUR bilateral equilibrium. 259 00:15:25,280 --> 00:15:28,840 Speaker 3: And what Lori Logan was arguing is that that creates 260 00:15:28,920 --> 00:15:32,600 Speaker 3: kind of a bifurcated distribution where the incentives to trade 261 00:15:32,640 --> 00:15:34,880 Speaker 3: in one market may not be the same as in 262 00:15:34,920 --> 00:15:39,480 Speaker 3: the other, more smaller triparty market. The result is that 263 00:15:39,960 --> 00:15:45,080 Speaker 3: you may be you know, looking at at an average 264 00:15:45,160 --> 00:15:48,800 Speaker 3: or a volume weighted media across all of these markets 265 00:15:49,200 --> 00:15:52,160 Speaker 3: that doesn't actually reflect what's going on in the market. 266 00:15:52,720 --> 00:15:56,080 Speaker 1: So what is the prospect of something fundamental changing and 267 00:15:56,160 --> 00:15:58,720 Speaker 1: what the FED targets? Okay, Lori Logan gives a speech, 268 00:15:58,760 --> 00:16:01,880 Speaker 1: but that's just a speech. And then if there were 269 00:16:02,000 --> 00:16:04,240 Speaker 1: going to be some change in what instrument or what 270 00:16:04,360 --> 00:16:07,720 Speaker 1: measured the FED targets, what are the technical challenges with 271 00:16:07,760 --> 00:16:08,600 Speaker 1: the new implementation. 272 00:16:09,240 --> 00:16:12,480 Speaker 3: So the short answer to that is, I don't know. 273 00:16:12,760 --> 00:16:15,040 Speaker 3: What I would say is that my sense is that 274 00:16:15,120 --> 00:16:19,040 Speaker 3: it's probably sooner than people think. Lorie Logan has given 275 00:16:19,080 --> 00:16:22,560 Speaker 3: her past career at the New York FED and the 276 00:16:22,720 --> 00:16:25,760 Speaker 3: SOMA or the kind of the implementation desk at the 277 00:16:25,760 --> 00:16:28,160 Speaker 3: FED probably has a lot of weight in terms of 278 00:16:28,240 --> 00:16:32,760 Speaker 3: how the mechanics of monetary policy run. As far as 279 00:16:32,800 --> 00:16:35,560 Speaker 3: the other members of the FMC, I'm not sure what 280 00:16:35,720 --> 00:16:39,040 Speaker 3: their opinions are because nobody's really discussed this in the past. 281 00:16:39,200 --> 00:16:42,680 Speaker 3: So I would say that probably sooner rather than later. 282 00:16:43,200 --> 00:16:45,800 Speaker 3: But something that's not going to happen, you know, let's 283 00:16:45,800 --> 00:16:49,840 Speaker 3: say within the next two years. Okay, Mechanically you know 284 00:16:49,880 --> 00:16:54,320 Speaker 3: there have been certainly in my career, the FED has 285 00:16:56,160 --> 00:16:59,160 Speaker 3: you know, targeted the FED funds rate for the entire 286 00:16:59,280 --> 00:17:03,360 Speaker 3: period of time. I'm but the way it communicates what 287 00:17:03,480 --> 00:17:07,440 Speaker 3: it's targeting has changed. So when I started, the FED 288 00:17:07,560 --> 00:17:12,359 Speaker 3: used to do daily operations and what kind of daily 289 00:17:12,400 --> 00:17:17,480 Speaker 3: liquidity operation. There were fine distinctions between them that would 290 00:17:17,480 --> 00:17:21,960 Speaker 3: indicate how much the FED was expecting the FED funds 291 00:17:22,040 --> 00:17:25,600 Speaker 3: rate to move up or down. Then in ninety four, 292 00:17:26,240 --> 00:17:28,720 Speaker 3: you know, they basically came out and said that we're 293 00:17:28,720 --> 00:17:32,320 Speaker 3: going to target the rate itself. And then after that 294 00:17:32,760 --> 00:17:34,840 Speaker 3: and I think it was ninety five, they actually started 295 00:17:34,840 --> 00:17:37,560 Speaker 3: publishing the target rate in the FMC minut. 296 00:17:37,480 --> 00:17:38,960 Speaker 1: Because it used to just be you had to you 297 00:17:38,960 --> 00:17:42,040 Speaker 1: would just into it right, it would just it would 298 00:17:42,119 --> 00:17:43,639 Speaker 1: arrive there and then they would figure out what the 299 00:17:43,680 --> 00:17:44,199 Speaker 1: target was. 300 00:17:44,440 --> 00:17:48,120 Speaker 3: Yeah, they used to use expressions like expected to put 301 00:17:48,520 --> 00:17:52,120 Speaker 3: modest pressure on reserve conditions. 302 00:17:51,600 --> 00:17:54,320 Speaker 1: Or because the FED has such a track record of 303 00:17:54,440 --> 00:17:57,639 Speaker 1: successfully targeting a rate, has that reduced the pressure to 304 00:17:57,720 --> 00:18:00,920 Speaker 1: actually trade in the market because word is so good. 305 00:18:03,160 --> 00:18:07,240 Speaker 3: I'm going to say no. I think that the reason 306 00:18:07,240 --> 00:18:10,240 Speaker 3: there's no trading in the FED funds market partly as 307 00:18:10,240 --> 00:18:13,359 Speaker 3: I said earlier, is that, you know, because it's a 308 00:18:13,480 --> 00:18:16,720 Speaker 3: Roman lake of sorts, it's kind of a negotiated interest rate. 309 00:18:16,960 --> 00:18:18,320 Speaker 3: It's not really a traded rate. 310 00:18:18,320 --> 00:18:20,119 Speaker 1: But I mean what I mean is like, does the 311 00:18:20,119 --> 00:18:23,200 Speaker 1: Fed does it not need to intervene directly as much 312 00:18:23,240 --> 00:18:25,760 Speaker 1: the way it did in the old days because everybody 313 00:18:25,880 --> 00:18:28,320 Speaker 1: knows that it can achieve it, and so the market 314 00:18:28,320 --> 00:18:30,160 Speaker 1: will take care of any deviations. 315 00:18:30,480 --> 00:18:35,439 Speaker 3: Yes, I think that's partly true. I think that you know, 316 00:18:36,720 --> 00:18:39,480 Speaker 3: that was originally the reason why they had a band 317 00:18:39,560 --> 00:18:43,080 Speaker 3: around the target, because they weren't sure in two thousand 318 00:18:43,119 --> 00:18:47,120 Speaker 3: and eight that they could achieve that. In the subsequent years, yes, 319 00:18:47,240 --> 00:18:51,280 Speaker 3: they've kind of eliminated the fine tuning that they would 320 00:18:51,320 --> 00:18:53,320 Speaker 3: need to do to get the FED funds right to 321 00:18:53,359 --> 00:18:53,880 Speaker 3: the target. 322 00:18:54,480 --> 00:18:58,160 Speaker 2: Okay, on the topic of nebulous FED words though, whether 323 00:18:58,200 --> 00:19:02,280 Speaker 2: it's modest or something like, ample reserves in the system 324 00:19:02,400 --> 00:19:06,640 Speaker 2: are still ample, but they are also falling. And meanwhile, 325 00:19:06,680 --> 00:19:10,680 Speaker 2: we've seen some repo rates going up recently. We had 326 00:19:10,800 --> 00:19:15,480 Speaker 2: the September fifteenth tax day, I guess September thirtieth quarter end, 327 00:19:16,280 --> 00:19:18,040 Speaker 2: there was a lot of concern that we might get, 328 00:19:18,200 --> 00:19:21,720 Speaker 2: you know, some sort of repo apocalypse as we used 329 00:19:21,720 --> 00:19:25,320 Speaker 2: to call it. That hasn't really materialized. But would you say, 330 00:19:25,480 --> 00:19:28,200 Speaker 2: overall the price of liquidity is going up. 331 00:19:28,440 --> 00:19:31,240 Speaker 3: Yes, I totally agree with that. So reserves may be 332 00:19:31,480 --> 00:19:35,520 Speaker 3: ample at the moment, but their price is going up 333 00:19:35,640 --> 00:19:39,240 Speaker 3: because the amount of that ampleness is getting smaller and smaller. 334 00:19:40,160 --> 00:19:42,760 Speaker 3: And their variety of reasons why it's getting smaller and smaller. 335 00:19:42,760 --> 00:19:46,520 Speaker 3: One of them is QT. The other was the resolution 336 00:19:46,600 --> 00:19:49,800 Speaker 3: of the debt ceiling, which you know encouraged the Treasury 337 00:19:49,800 --> 00:19:54,360 Speaker 3: to kind of target a higher cash balance for precautionary reasons. 338 00:19:54,560 --> 00:19:58,680 Speaker 3: There was a speech recently by Hunter McMaster about what 339 00:19:58,760 --> 00:20:04,320 Speaker 3: the treasuries can balance target or goal or desired level is, 340 00:20:04,720 --> 00:20:07,760 Speaker 3: which is five to seven days of expected outflows. And 341 00:20:07,800 --> 00:20:10,360 Speaker 3: so they want to maintain an ample balance in their 342 00:20:10,440 --> 00:20:14,000 Speaker 3: checking account. But the Treasury's checking account is held at 343 00:20:14,000 --> 00:20:17,760 Speaker 3: the Federal Reserve, and that acts as a liability for 344 00:20:17,800 --> 00:20:20,680 Speaker 3: the FED, so it drains reserves as the balance goes up. 345 00:20:21,160 --> 00:20:23,840 Speaker 3: So all of these factors have kind of been moving, 346 00:20:24,520 --> 00:20:28,000 Speaker 3: and up until now, most of the decline in the 347 00:20:28,000 --> 00:20:31,200 Speaker 3: Fed's balance sheet is shown up as a shift out 348 00:20:31,240 --> 00:20:34,760 Speaker 3: of the reverse repo program, which is meant to mop 349 00:20:34,880 --> 00:20:40,880 Speaker 3: up excess reserves and the Treasury's account. Now what's happening 350 00:20:40,960 --> 00:20:45,239 Speaker 3: is that there's nothing left in the RP program, and 351 00:20:45,280 --> 00:20:48,720 Speaker 3: as the balance sheet shrinks further, it comes out of reserves. 352 00:20:49,480 --> 00:20:52,040 Speaker 3: As it comes out of reserves, the effect is kind 353 00:20:52,040 --> 00:20:56,080 Speaker 3: of disproportionate, if you will. Most of the reserve loss 354 00:20:56,119 --> 00:20:59,520 Speaker 3: that we've seen has come from foreign banks. Foreign banks 355 00:20:59,560 --> 00:21:01,880 Speaker 3: are the ones who are trading in the Fed funds market, 356 00:21:02,600 --> 00:21:06,200 Speaker 3: so their cost of liquidity is going up, right there, 357 00:21:06,520 --> 00:21:12,000 Speaker 3: bargaining power in this, you know, negotiation has deteriorated and 358 00:21:12,040 --> 00:21:14,000 Speaker 3: they have to pay an extra basis point. That's what 359 00:21:14,040 --> 00:21:15,439 Speaker 3: we've seen in recent days. 360 00:21:16,320 --> 00:21:19,200 Speaker 1: Last question for me, you've seen any interesting have any 361 00:21:19,240 --> 00:21:21,719 Speaker 1: interesting thoughts these days about stable coins or how that 362 00:21:21,800 --> 00:21:23,320 Speaker 1: interacts with some of these markets. 363 00:21:23,840 --> 00:21:27,920 Speaker 3: So the idea behind the stable coins as a payment mechanism, 364 00:21:28,520 --> 00:21:34,080 Speaker 3: right that they look similar to a money market fund, 365 00:21:34,080 --> 00:21:37,040 Speaker 3: and because they're similar in structure to a money market fund, 366 00:21:37,359 --> 00:21:40,840 Speaker 3: the idea is that they would have to buy short 367 00:21:40,920 --> 00:21:43,760 Speaker 3: duration assets, right, they'd have to buy treasure repo, they 368 00:21:43,880 --> 00:21:47,440 Speaker 3: have to buy treasury bills. So the goal or the 369 00:21:47,520 --> 00:21:51,440 Speaker 3: intent is that if demand for stable coins goes up, 370 00:21:51,920 --> 00:21:54,760 Speaker 3: the demand for bills will go up, and therefore the 371 00:21:54,800 --> 00:21:58,760 Speaker 3: treasure will find a new buyer for treasury bills, and 372 00:21:58,800 --> 00:22:03,040 Speaker 3: it could issue more treasure bills without pushing interest rates up. Right, 373 00:22:03,520 --> 00:22:10,080 Speaker 3: And if your goal hypothetically is to increase bill supply 374 00:22:10,720 --> 00:22:14,480 Speaker 3: but reduce the supply of term debt in order to 375 00:22:14,560 --> 00:22:18,280 Speaker 3: keep term interest rates from rising, then you need a 376 00:22:18,320 --> 00:22:25,320 Speaker 3: new large buyer of treasury bills. Right. That buyer theoretically 377 00:22:25,359 --> 00:22:28,240 Speaker 3: could be stable coins or at least a payment token 378 00:22:28,320 --> 00:22:32,720 Speaker 3: of some sort. The problem, of course, is that when 379 00:22:33,440 --> 00:22:38,240 Speaker 3: the demand for payment tokens goes up, it's taking away 380 00:22:38,320 --> 00:22:42,840 Speaker 3: from the demand of some other instruments that people use 381 00:22:42,920 --> 00:22:51,399 Speaker 3: for making payments deposits, credit cards, and paper currency. So 382 00:22:52,040 --> 00:22:54,800 Speaker 3: my sense, at least from looking at this and having 383 00:22:55,119 --> 00:22:58,159 Speaker 3: thought about it somewhat, is I think of the payment 384 00:22:58,240 --> 00:23:06,000 Speaker 3: tokens as a closer substitute for currency than a you know, 385 00:23:06,040 --> 00:23:11,560 Speaker 3: than a bank deposit. If you think about currency generally, right, 386 00:23:11,720 --> 00:23:18,119 Speaker 3: there's I think the average on person currency amount is 387 00:23:18,160 --> 00:23:21,800 Speaker 3: about sixty dollars, but per capita currency in the US 388 00:23:21,960 --> 00:23:25,360 Speaker 3: is something like seven thousand dollars or more. So there's 389 00:23:25,400 --> 00:23:30,480 Speaker 3: a significant volume of US currency that's held offshore, right, 390 00:23:30,560 --> 00:23:34,000 Speaker 3: some estimates between five eighth five eighths of US currency 391 00:23:34,040 --> 00:23:38,680 Speaker 3: is held offshore. There are nineteen billion one hundred dollars 392 00:23:38,720 --> 00:23:39,560 Speaker 3: bills out. 393 00:23:39,400 --> 00:23:43,600 Speaker 1: There, nineteen billion one hundred dollars bills, Yes, so none 394 00:23:43,640 --> 00:23:45,960 Speaker 1: of them, No, I have a feel really yeah for 395 00:23:46,000 --> 00:23:47,280 Speaker 1: the less, if I played Pokemon. 396 00:23:47,040 --> 00:23:47,960 Speaker 2: You keep them in your wallet. 397 00:23:48,080 --> 00:23:49,520 Speaker 1: I have them in my bedside drawer. 398 00:23:50,840 --> 00:23:53,160 Speaker 3: So you're part of the exception rather than the rule. 399 00:23:53,400 --> 00:23:59,199 Speaker 3: But my point being that a payment token, probably the 400 00:23:59,280 --> 00:24:02,200 Speaker 3: demand for it may be higher outside the US than 401 00:24:02,240 --> 00:24:05,200 Speaker 3: inside the US, because you have revolt lots of ways 402 00:24:05,200 --> 00:24:09,760 Speaker 3: of making fast payments. Where it might be more attractive 403 00:24:09,800 --> 00:24:14,680 Speaker 3: is in underbanked economies that are able to access mobile phones, 404 00:24:15,240 --> 00:24:17,439 Speaker 3: and so all things being equal, you could say it 405 00:24:17,520 --> 00:24:19,320 Speaker 3: is a substitute for the one hundred dollars bill, is 406 00:24:19,320 --> 00:24:22,800 Speaker 3: a store of value and a unit of account. And 407 00:24:22,880 --> 00:24:26,160 Speaker 3: in that case then you could potentially see strong demand 408 00:24:26,320 --> 00:24:29,480 Speaker 3: for payment tokens, but they would be located outside the US. 409 00:24:29,920 --> 00:24:33,719 Speaker 3: The other area would be with respect to remittances, so 410 00:24:33,880 --> 00:24:38,080 Speaker 3: sending money abroad again much easier to do with a 411 00:24:38,119 --> 00:24:43,040 Speaker 3: payment token. Making purchases theoretically using your credit card in 412 00:24:43,080 --> 00:24:49,280 Speaker 3: a non US currency sometimes can get hard, partly because 413 00:24:49,320 --> 00:24:52,879 Speaker 3: of anti fraud and other mechanisms. If you use the 414 00:24:52,960 --> 00:24:55,760 Speaker 3: stable coin, that might be easier. But the problem, of 415 00:24:55,800 --> 00:24:59,400 Speaker 3: course is that a stable coin used in that way 416 00:25:00,200 --> 00:25:03,320 Speaker 3: is just like using money right or paper money right. 417 00:25:03,400 --> 00:25:08,320 Speaker 3: Once it's gone right, you can't call your credit card 418 00:25:08,400 --> 00:25:10,159 Speaker 3: company and say stop that payment. 419 00:25:10,880 --> 00:25:14,480 Speaker 2: I'm going to squeeze in. One more question on swap spreads, 420 00:25:14,520 --> 00:25:17,200 Speaker 2: which was actually the original reason why I reached out 421 00:25:17,200 --> 00:25:19,560 Speaker 2: to you, but then Lori Logan made her speech and 422 00:25:19,760 --> 00:25:24,000 Speaker 2: we got very distracted. But swap spreads, there's something going 423 00:25:24,040 --> 00:25:26,560 Speaker 2: on there, which is they seem to be widening, not 424 00:25:26,680 --> 00:25:29,080 Speaker 2: just in the US, but basically all around the world, 425 00:25:29,160 --> 00:25:34,440 Speaker 2: so Australia, Japan, Canada. I think what is going on there? 426 00:25:34,600 --> 00:25:36,879 Speaker 2: And why should we care about swap spreads? 427 00:25:37,520 --> 00:25:40,879 Speaker 3: So I'm not an expert on swap spreads, but I 428 00:25:40,920 --> 00:25:46,080 Speaker 3: will say is that there's a general global theme about 429 00:25:46,359 --> 00:25:50,320 Speaker 3: fiscal prudence, if you will, and that the amount of 430 00:25:50,320 --> 00:25:54,520 Speaker 3: government debt outstanding is increasing and doesn't seem to be 431 00:25:54,560 --> 00:25:58,119 Speaker 3: going anywhere but up. The result of that is that 432 00:25:58,160 --> 00:26:02,920 Speaker 3: people demand a premium for holding that government debt. And 433 00:26:03,080 --> 00:26:05,600 Speaker 3: that's what we're seeing here, which is that that premium 434 00:26:05,640 --> 00:26:08,399 Speaker 3: has started to rise. Now. Initially in the US, the 435 00:26:08,520 --> 00:26:12,560 Speaker 3: sense was that after the certainly in April of this year, 436 00:26:12,880 --> 00:26:16,200 Speaker 3: that premium was expected to be higher. But I think 437 00:26:16,240 --> 00:26:19,439 Speaker 3: what happened in the US was that people recognize that 438 00:26:21,000 --> 00:26:25,520 Speaker 3: the deterioration in the fiscal outlook was not a unique 439 00:26:25,760 --> 00:26:29,200 Speaker 3: US phenomena, right, It was occurring across the board, certainly 440 00:26:29,240 --> 00:26:31,480 Speaker 3: in the countries, among the countries that you were mentioning. 441 00:26:32,040 --> 00:26:35,320 Speaker 3: So I think there's a I don't want to call 442 00:26:35,359 --> 00:26:38,800 Speaker 3: it bond vigilanteism, because I don't think that's what's going on, 443 00:26:38,920 --> 00:26:44,000 Speaker 3: but there is a realization that fiscal policy is moving 444 00:26:44,040 --> 00:26:46,960 Speaker 3: in presumably an unsustainable direction. 445 00:26:47,119 --> 00:26:50,399 Speaker 2: Although weirdly the UK one hasn't moved that much. 446 00:26:51,080 --> 00:26:52,720 Speaker 1: Yeah, I know, they got so much excitement at the 447 00:26:52,760 --> 00:26:55,440 Speaker 1: beginning of September and then it's been kind of chill. 448 00:26:55,680 --> 00:27:02,919 Speaker 2: Yeah, Well, we'll see what happens. Lots More is produced 449 00:27:02,920 --> 00:27:05,840 Speaker 2: by Carmen Rodriguez and Dashel Bennett, with help from Moses 450 00:27:05,880 --> 00:27:07,320 Speaker 2: Ondam and Cal Brooks. 451 00:27:07,640 --> 00:27:10,720 Speaker 1: Our sound engineer is Blake Maples. Sage Bauman is the 452 00:27:10,720 --> 00:27:12,120 Speaker 1: head of Bloomberg Podcasts. 453 00:27:12,320 --> 00:27:15,439 Speaker 2: Please rate, review, and subscribe to ad lots and lots 454 00:27:15,480 --> 00:27:18,440 Speaker 2: more on your favorite podcast platforms. 455 00:27:18,200 --> 00:27:20,800 Speaker 1: And remember that Bloomberg subscribers can listen to all of 456 00:27:20,840 --> 00:27:24,720 Speaker 1: our podcasts add free by connecting through Apple Podcasts. Thanks 457 00:27:24,800 --> 00:27:25,280 Speaker 1: for listening.