Speaker 1: Hello, and welcome to another episode of the Odd Thoughts podcast.
Speaker 1: I'm Tracy Alloway. My co host Joe Wisenthal is away
Speaker 1: this week. I am recording this on September one, which
Speaker 1: means it is the start of a new quarter. And
Speaker 1: whenever we have the start of a new quarter, it's
Speaker 1: usually a time to start reflecting on what's happening in
Speaker 1: money markets. And there has been a lot happening in
Speaker 1: money markets so far this year. So you know, just
Speaker 1: today we have a d two participants placing one point
Speaker 1: one nine trillion dollars at the FEDS Reverse Repurchase Agreement Facility,
Speaker 1: the Reverse Repo Facility UM. And I have to say,
Speaker 1: the US financial system right now is kind of a
Speaker 1: wash in liquidity, and it has been for some time,
Speaker 1: and that's causing problems for banks who have to handle
Speaker 1: all these deposits, problems for money market funds, and of
Speaker 1: course problems for the FED. So all this liquidity means
Speaker 1: that money market rates have basically been pressured lower all
Speaker 1: year UM, so much so that the FED has actually
Speaker 1: had to tweak some of its facilities, including the reverse
Speaker 1: repot facility, back in June to prevent those rates from
Speaker 1: going even lower and more recently it surprised the market
Speaker 1: by introducing a standing repot facility. So we have had
Speaker 1: a lot of requests to talk about this on all lots,
Speaker 1: and no surprise, we've had requests to speak to one
Speaker 1: person in particular, repeat all loots guests, We're gonna be
Speaker 1: talking to re Sultan Posar, of course, the equobal head
Speaker 1: of short term interest rates over at Credit Swiss. Sultan,
Speaker 1: welcome to the show again. Thank you very much for
Speaker 1: having me back. So I'm trying to think where to start,
Speaker 1: but maybe you could begin by describing the general state
Speaker 1: of liquidity and money markets at the moment. Like when
Speaker 1: I say the financial system is a wash in liquidity,
Speaker 1: what exactly do we mean the general What is the
Speaker 1: general state? The general state is things that haven't happened
Speaker 1: before are now happening. So so again, let's let's perhaps
Speaker 1: start with cross curency basis. This is something that we
Speaker 1: are used to as as being very negative. You know,
Speaker 1: there is also there's always an excess demand for dollars,
Speaker 1: and that excess demand for for for dollars has gone
Speaker 1: to cross curency basis is pretty much closed. You have
Speaker 1: some jurisdictions smaller countries for the cross currency basis is
Speaker 1: even positive Mexico, South Africa, in China's you know, these
Speaker 1: are these are these are quite unusual things. Library is
Speaker 1: dormant and in the base still wise is three basis
Speaker 1: points very tight. People and bill yields are are very low.
Speaker 1: And you know, but this, but this is a reflection
Speaker 1: of the is naturally just you know, too much cash
Speaker 1: in the system relative to demand for this funny you know,
Speaker 1: I think, unfortunately, I think we are in a period
Speaker 1: where things are going to be very different for quite
Speaker 1: some time relative to how things were over the past
Speaker 1: five years. I think over the past five years we've
Speaker 1: had sort of a golden era for stir traders because
Speaker 1: we've had so many, so many spread moves in the
Speaker 1: money markets. You know, the liboiary basis or the cross
Speaker 1: currency basis has done. You know, the people markets acted
Speaker 1: out in the past. But if you think about why
Speaker 1: liquidity was tight as opposed to abundance, they're basically three weeks.
Speaker 1: You know, the FED stubbed QUEI in twenty fifteen, and
Speaker 1: then the ECB and the d o J were just starting.
Speaker 1: So we were in this position where there was an
Speaker 1: excess supply of euro and a end people didn't know
Speaker 1: what to do. The responsed for dollars, so that rope
Speaker 1: that that special as the dollar in in the xpot market.
Speaker 1: Then we had fossil free that was getting rolled out,
Speaker 1: and so nobody understood that, right, So you had this
Speaker 1: relative shortage of dogs combined with an ever growing shortage
Speaker 1: of balance sheet for various parts of basil getting rolled
Speaker 1: out l C R, SLR GC S. Course, you know,
Speaker 1: the banks themselves had to learn how to manage these ratios,
Speaker 1: the market learn how to trade these ratios, and then
Speaker 1: we had these little idiosyncredic things like money funderform, corporate
Speaker 1: text reform, and so these rollways back in the rent
Speaker 1: some of the most experienced STIR traitors will tell you
Speaker 1: that they've never traded as much front and basis in
Speaker 1: their career. You know, some of those careers spent thirty
Speaker 1: years as they did between twenty fifteen, and so then
Speaker 1: you fast forward to today. We now have so much liquidity. Uh,
Speaker 1: and this is this is particularly a case for the US.
Speaker 1: Do learn that you know, the FED is doing que
Speaker 1: faster than than the B O J or the E
Speaker 1: C B. So so there is, there's just an ample
Speaker 1: supply view as dollars. Regulations are not getting tighter, if anything,
Speaker 1: they are getting easier. The FED has become a dealer
Speaker 1: of less resorts, the swap mindes. We have the standing
Speaker 1: people facility before banks. We have to standing people facility
Speaker 1: for foreign central banks. So so this is a very
Speaker 1: different environment. And then in the midst of this, you know,
Speaker 1: a lot of the community, a lot of balance sheets,
Speaker 1: a lot of excess cassion systems. There's also you know,
Speaker 1: not as much activity in the world economy that needs
Speaker 1: to get announced. So if you just think about why
Speaker 1: foreign banks elsewhere, you know, borrow dollars because they need
Speaker 1: to finance traight those or or whatnot's death demand is dormant.
Speaker 1: I think I think capital clothes are a bit more domestic.
Speaker 1: You know, the the FX hedge cloths are not as
Speaker 1: dominant as they the relative value hedge funds a kind
Speaker 1: of checked out at the moment because there's not a
Speaker 1: lot of opportunities and so you know, there's you know,
Speaker 1: the best reflection of of all these sex cases you
Speaker 1: mentioned is all this one point actually, and that is
Speaker 1: of cash that's sitting in the report facility that you
Speaker 1: literally want to think about as money the system doesn't need,
Speaker 1: either because it doesn't have the balance sheet for it,
Speaker 1: or because there's no use or outfit for that money.
Speaker 1: All right, This brings me to my next question, because
Speaker 1: I think a lot of people when they hear that
Speaker 1: the system is a washing liquidity, there's all this excess cash,
Speaker 1: a lot of people wouldn't necessarily think that's a bad thing.
Speaker 1: And yet you know, clearly this is something that the
Speaker 1: Fed at least has been responding to. Um I mentioned
Speaker 1: that it tweaked the reverse reboth facility and then it
Speaker 1: started the standing repo facilities. What exactly is the problem here? Well,
Speaker 1: I wouldn't say that it's a problem. I think that
Speaker 1: the way I think that the way all this is
Speaker 1: clearing in the system is actually quite do you beutiful
Speaker 1: and kind of hastlement and problem free? I think you're
Speaker 1: the only person that would describe us as beautiful. Well, look,
Speaker 1: I think it's beautiful because you know, the designed the
Speaker 1: system basically, so you know, I mean, you put you
Speaker 1: put reserves in. You know, the central bank is a
Speaker 1: balance sheet, and then someone has to hold the liabilities
Speaker 1: of central bank, and we have a beautiful mechanism where
Speaker 1: you know this money is going to flow through the
Speaker 1: past path of reefs, resistance to whoever has the balance
Speaker 1: and so and so that's what we're seeing. And again
Speaker 1: you know the reverse reple facility. You literally want to
Speaker 1: think about there as foam on the runway, So it
Speaker 1: doesn't matter how big a plane you're gonna eventually crashed
Speaker 1: on the runway. There's a lot of foam there, so
Speaker 1: the impact is not going to be painful. So what
Speaker 1: do I mean by that? You know, people people talk
Speaker 1: about let's find let's find some some you know, stread
Speaker 1: opportunity we can trade in the money. Maybe there's gonna
Speaker 1: be a run on teather and you know that that
Speaker 1: tater is going to have to sell you know, sixty
Speaker 1: billion dollars of commership or something like that. I mean,
Speaker 1: you know, there these ideas floating out there because we
Speaker 1: don't really have a lot of ideas to trade. So
Speaker 1: what would happen in such a scenario? Nothing? I mean
Speaker 1: on money fund complex that has one point two trillion
Speaker 1: dollars stashed away at the at the reverse ory earning
Speaker 1: five basis points whatever this location you go hav in
Speaker 1: the CP market from someone having to sell sixty billion
Speaker 1: dollars commercial paper hypothetically is going to be scooped up
Speaker 1: and they will be asking for more opportunities like that, right,
Speaker 1: So this is this is just exper cash that will
Speaker 1: be there too to get deployed to to harvest whatever
Speaker 1: spread having affex swamps or or or spy or live
Speaker 1: or or so so that's a lot. Now people often
Speaker 1: bring up, you know, this is a problem for the banks,
Speaker 1: but again this is not really a problem for the banks,
Speaker 1: because you know, the banks now have again and I
Speaker 1: think it's quite beautiful a mechanism whereby if in the
Speaker 1: morning they have cash coming in that they don't have
Speaker 1: the balance sheet for, they can just push that cash
Speaker 1: away in the afternoon, you know, and so that money
Speaker 1: that that that comes in in the morning and swells
Speaker 1: the bank's balance sheets to push it away into the
Speaker 1: money funds and the money funds can taste it at
Speaker 1: the reverse people facility. You know, this is a mechanism
Speaker 1: that enables the system to kind of clear and and
Speaker 1: get around the balance sheet bottlenecks. And you know, the
Speaker 1: reverse triple facility has no limits. I mean, it's eighty
Speaker 1: billion dollars per counter party. We are, you know, some
Speaker 1: distance away still from some some accounts maxing out the
Speaker 1: kind of party limit, but you know, the set indicated
Speaker 1: that they can base the kind of party cap to
Speaker 1: to a much higher number. So so really there's there's
Speaker 1: there's no limits to you know, this system is well designed,
Speaker 1: it's well built, it's working, and it's doing what it's
Speaker 1: supposed to do. And frankly, I think, you know, all
Speaker 1: this money that's going into money funds and ultimately it
Speaker 1: is getting deployed in the in the reverse report facility,
Speaker 1: you want to think about it two ways. You know,
Speaker 1: there's two things happening. Number one, we have massive bill
Speaker 1: paidowns that are happening at the moment, because that's something
Speaker 1: to talk about. But you know, there's these bill paidowns
Speaker 1: and so money funds are losing the current asset that
Speaker 1: they have in their existing book of business and then
Speaker 1: they have cash coming and then they need to places
Speaker 1: somewhere else. And that's the RRP facilities. So that's just
Speaker 1: a rotation within within these money fund portfolios. The other
Speaker 1: is new money that into the money funds, and that
Speaker 1: new money is the money that the large banks are
Speaker 1: are pushing away because they don't have the balance sheet
Speaker 1: for them. And so there is something very very interesting happen,
Speaker 1: which is which is that at any given point in time,
Speaker 1: when the bank gets a new deposits, especially under COVID,
Speaker 1: it's either a new deposit because there is q WE happening.
Speaker 1: And it's how you know, when q WE have, the
Speaker 1: pasites get created in the banking system, but those are
Speaker 1: low quality deposits, become institutions sold a bond to the
Speaker 1: Fed and got that institutional hot money that doesn't really
Speaker 1: have a lot of value from the perspective of the bank.
Speaker 1: So the banks are pushing that stuff away. And then
Speaker 1: there's also still a lot of stimulus happening, you know,
Speaker 1: unemployment insurance text you're going out, we have COVID payments,
Speaker 1: we have all sorts of payments that the government is
Speaker 1: still making to the households. Those are the good deposits.
Speaker 1: So if you have a banking system that is balance constrained,
Speaker 1: then the largest banks are balancing extreme in the US.
Speaker 1: You know, this is also a mechanism that enables these
Speaker 1: banks to take all these deposits as they are coming
Speaker 1: in and then at the end of the day make
Speaker 1: a choice as to this is good quality, this is
Speaker 1: bath quality. So the good quality I want to make
Speaker 1: room for him at Talantreet and I want to retain it.
Speaker 1: And it's bad stuff. I just want to push away
Speaker 1: into the money fund because it's absolutely no value from
Speaker 1: from from a liquidity perspective, and so it's actually a
Speaker 1: facility that helps the banks to cherry pick of the
Speaker 1: posits they want old and so it works, it works,
Speaker 1: and you know, you know, we often think about the
Speaker 1: RP facility as the floor underpinning the basement of money
Speaker 1: market trades, and it's and it's a floor to money
Speaker 1: market trads too, So I think it's big, but it's
Speaker 1: doing as it's supposed to do. And frankly, absolutely no
Speaker 1: difference between you know, treasuries cash banans being at one
Speaker 1: and a half Julian or the reverse reposacility being at
Speaker 1: one and a half Julian. It's it's the same thing.
Speaker 1: It's just there's a different mechanisms through which the system
Speaker 1: was it So if the reverse were facility is successful
Speaker 1: in the sense that you know, it's setting the floor
Speaker 1: on interest rates um and it's soaking up this excess
Speaker 1: on liquidity in the system. Why did the FED fuel
Speaker 1: the need to start paying interest on it? So you know,
Speaker 1: interest used to be zero and then in June the
Speaker 1: FED raised it to five basis points. And here I
Speaker 1: think I should note that this is actually a call
Speaker 1: that you got wrong, right, you You weren't expecting them
Speaker 1: to raise that interest. So what's going on there? And
Speaker 1: what's your take on that? Yes, that that's that's a call.
Speaker 1: That's a call I get wrong. Look, I think I
Speaker 1: would say it's an extreme aversion to negative interest rates
Speaker 1: in the us UM which I basically which I basically misread.
Speaker 1: You know, the interest on the reverse people was raised
Speaker 1: to five basis points because I mean, look, the backdrop
Speaker 1: part this is, you know, if you're the FED, you
Speaker 1: have two groups talked to all the time, the banks
Speaker 1: and the money fund The banks are telling you I
Speaker 1: can't take any more to passes because I'm cool. You know,
Speaker 1: I have an SLR and I have an SLAR constrained.
Speaker 1: You know, the reserves haven't been exempted from the SAR.
Speaker 1: I'm not going to take the money funds are telling
Speaker 1: you what. I'm not going to take the money either,
Speaker 1: because you know the rps are zero. I have certain
Speaker 1: fixed costs, variable costs that are a function on my
Speaker 1: assets under management. So I need to be able to
Speaker 1: make a buck, you know, if I take new money.
Speaker 1: You know, my my argument was basically, you can money
Speaker 1: fund could ultimately charge charge the end investors a fee
Speaker 1: for or for taking their money. I think it would
Speaker 1: be the end of the world. Um, because at the
Speaker 1: end of the day, the FET cares about the constellation
Speaker 1: of the administered of the of the of the overnight
Speaker 1: rates that it's looking at, which are all inter bank grates.
Speaker 1: You know, FET funds, euro dollars, soper repo, all that stuff.
Speaker 1: But you know, the FET shouldn't really care about the
Speaker 1: rate two end investors. Right, there's a big difference between
Speaker 1: rates to end investors and inter bank rates. Because that
Speaker 1: was my prior and so, as you said, I was wrong.
Speaker 1: But what did we learned from this from this episode
Speaker 1: of being wrong. I think what we've learned is that,
Speaker 1: you know, the FED care is not only about these
Speaker 1: inter bank rates, but the FED also cares about rates
Speaker 1: to end investors. They are averse to even bill yields
Speaker 1: going negative in episodes other than a master prisis you
Speaker 1: know last March. They don't want money fund fields to
Speaker 1: be negative. They don't want the positive rates in the
Speaker 1: banking system to be to be negative. So so they
Speaker 1: basically just raised the r a period to five basis points.
Speaker 1: I think the money funds got an asset that is
Speaker 1: sufficient for them to which yields enough for them to
Speaker 1: be able to cover their costs to even charge the
Speaker 1: feed to investors, and for the end investors to end
Speaker 1: up with with a with a with a positive field.
Speaker 1: So I think I think the you know, the short
Speaker 1: answer is there's that extreme aversion the negative. It's just
Speaker 1: something beyond the the US. I'm kind of amused that
Speaker 1: so many people complain about the FED manipulating interest rates
Speaker 1: and meanwhile the FED is concerned about private actors manipulating
Speaker 1: interest rates downwards to a to a negative level. So
Speaker 1: one of the reasons Joe and I love having you
Speaker 1: on the show Resultan is because you do this research
Speaker 1: that is incredibly granular, where you talk about, you know,
Speaker 1: the individual incentives for each bank, why they do the
Speaker 1: things that they do. You just touch on it, you know,
Speaker 1: with the Federal Reserve, the idea that the FED is
Speaker 1: absolutely loath to have negative rates in the headlines basically, Um,
Speaker 1: can you walk us through exactly how banks are thinking
Speaker 1: about various forms of cash like instruments at the moment.
Speaker 1: So you know, when we say the system is a
Speaker 1: washing liquidity, that liquidity kind of comes in different formats.
Speaker 1: So you know, you can have US treasuries, you can
Speaker 1: have agency nbs, um, you can have excess reserves that
Speaker 1: banks get from the FED. And I'm wondering, like, how
Speaker 1: are banks thinking about that mix at the moment. Well, Um,
Speaker 1: it's a it's it's it's a simple it's a simple answer.
Speaker 1: At various points over the past five years. You know,
Speaker 1: these liquidity portfolios are always are always being up. So
Speaker 1: you know, whatever is the yield st that's that's what
Speaker 1: the banks do with that liquidity. Look. Uh, sometimes you
Speaker 1: know they lend into the reple market because it feels
Speaker 1: better than underserves at the FED. Interest on reserves is
Speaker 1: always there is the starting point, of course. Uh. Sometimes
Speaker 1: you lend in the f X spot market because yields
Speaker 1: are much better there. And in both of these cases,
Speaker 1: you know, the opportunity set is pretty it's pretty bad.
Speaker 1: I mean, you know REPO is well below I O
Speaker 1: or as I said, you know, the relative value you
Speaker 1: hedge from community. It's kind of checked out at the
Speaker 1: moment because there's there's not a lot of you know,
Speaker 1: bond basis opportunities um to to to put on and
Speaker 1: to the funds. So so the report market is is
Speaker 1: very quiet. The fx pop market. Similarly, when you look
Speaker 1: at you know, the the very front and points in
Speaker 1: the fx S pop market for these tanks are active
Speaker 1: tom next spot next points implied yields are just the
Speaker 1: basis point above io. We are, I mean, we've never
Speaker 1: seen things this tide since pots of peoples rolled out.
Speaker 1: So this is this is uh, this is again what
Speaker 1: we started the conversation with. It's too much, too much security,
Speaker 1: not a demand for this cash. Sometimes, you know, the
Speaker 1: fx S pop market and the report market will also
Speaker 1: each other and so the fex pop market can pull
Speaker 1: the report rates up. But so money markets again or doormant.
Speaker 1: So if you're a bank portfolio, you cannot truly do
Speaker 1: anything but go out and when you go out the curve,
Speaker 1: you will be looking at other age curity, which is
Speaker 1: which is mortgages, mortgages and treasuries, and then you know
Speaker 1: you can you can buy these treasuries which offer a
Speaker 1: spread over row I s or can buy it out right,
Speaker 1: you can buy it, buy it an asset spot. But
Speaker 1: basically treasury securities are the frontier. And when you look
Speaker 1: at when you look at the bank h portfolios, you
Speaker 1: will you will see that you know, they have they
Speaker 1: have added a lot of treasury securities under the pandemic.
Speaker 1: And so you know, good for you as government because
Speaker 1: they have a lot of paper that they that they
Speaker 1: need to issue. But that's basically where the money is
Speaker 1: going at the at the moment. I think I think
Speaker 1: it would also be interesting to kind of dig into,
Speaker 1: you know, some bank by bank examples of ending in
Speaker 1: this department, because you know, when we talk about banks,
Speaker 1: it sounds like it's plural, right, because there's a lot
Speaker 1: of banks. But actually what's happening is that there's only
Speaker 1: two banks really that have done all the heavy lifting
Speaker 1: in terms of in terms of buying all these treasuries,
Speaker 1: and and that those two banks are Hip Morgan and
Speaker 1: Bank of America. These are these are two of the
Speaker 1: most important creditors to the US government at the moment,
Speaker 1: other than other than the set up of course, you know,
Speaker 1: but but these are two banks that that approached their
Speaker 1: their bond buying strategy completely differently. And you know what
Speaker 1: I will say now is you know some of the
Speaker 1: things that have been said at at these banks earnings
Speaker 1: calls and so it's not not an inside d or
Speaker 1: anything like that. You know, the Bank of America's management
Speaker 1: has mentioned a number of times and they're on their
Speaker 1: earnings calls that they are they are happy with the
Speaker 1: fact that they have called the bottom in rates during
Speaker 1: the third quarter of twenty twenty. They have been slowing
Speaker 1: all their access security into into the mortgage markets ever since.
Speaker 1: So they have this programmatic buying of treasury securities and
Speaker 1: they are always in the market regardless of of abew.
Speaker 1: That was simply because you know, that's a bank that
Speaker 1: has that has a management philosophy where look, there is
Speaker 1: no low demands, but these deposits keep coming in. So
Speaker 1: we're a bank. So if the deposits are coming in
Speaker 1: but there's no law demand, we have to do something
Speaker 1: with this excess case. So we just you know, buy securities.
Speaker 1: If households and corporations don't borrow, but the government does.
Speaker 1: You know, we're just underprid that. JP Morgan is a
Speaker 1: bit more different because they always have you know, strong
Speaker 1: views about rates, and so Jamie Diamonds letter to shareholders
Speaker 1: and he basically said, kilds are moving higher, elation is
Speaker 1: coming that is going to have to chase down this
Speaker 1: the patience. The yields are going higher, so we will
Speaker 1: hold off on spending all the fact hundred billion dollars
Speaker 1: of reserves that we have a FED until yield will higher.
Speaker 1: And so you know they didn't spend any of this money.
Speaker 1: Bank of America has been programmatic buying. I guess the
Speaker 1: question from here going forward, is JP Morgan going to
Speaker 1: adapt to a world where and this is this is
Speaker 1: a good segue into into the standing people facility and
Speaker 1: this idea of dealer of last resort. You know in
Speaker 1: my writings and I think I mentioned this one it's
Speaker 1: called too before. JP Morgan was always the lender of
Speaker 1: next to last resorts of the system, right because before
Speaker 1: the FED would stop in, you know, they had always
Speaker 1: the most amount of reserves in the system. So whether
Speaker 1: it was the FX swap market that was acting out
Speaker 1: or the report market, you know, it was JP Morgan
Speaker 1: lending into it. On the margin, there was value. There
Speaker 1: was a lot of value in having all these sex
Speaker 1: as cash because uh, you know, as Warren Buffett would say,
Speaker 1: you know, cash has option value. So if you're a
Speaker 1: bank portfolio, and especially if you're JP Morgan and your
Speaker 1: heart of the financial system, you need to have that
Speaker 1: cash to be able to kind of lend into these
Speaker 1: money markets. Location right now, that opportunity that is extremely poor.
Speaker 1: I mean, the only the only thing, the only thing
Speaker 1: that gets people excited here and turned, which is which
Speaker 1: is just pretty depressing by the way, so all year
Speaker 1: there's nothing to do with the year in turn, you
Speaker 1: have to kind of handicap that. But so that opportunity
Speaker 1: is pool. Fields were supposed to go higher, but they didn't.
Speaker 1: They went lower. You know, we have a taper announcement.
Speaker 1: Fields didn't do anything on the back of that. So
Speaker 1: I think it would be very interesting to see during
Speaker 1: the second half of the year how this posture at
Speaker 1: at this that this bank is going to change going forward,
Speaker 1: because if Fields are not moving higher, they're basically giving
Speaker 1: up a lot of net interest income that other banks
Speaker 1: are earned. And so it was just very interesting. You know,
Speaker 1: there there is this theory out there that bank demand
Speaker 1: for treasuries to satisfy the liquidity requirements has been one
Speaker 1: of the factors, you know, maybe even a very important
Speaker 1: factor in keeping yields very low um And you know,
Speaker 1: this was sort of a mystery in markets um over
Speaker 1: the summer and in the spring, Why our treasury yields
Speaker 1: so low when it looked like the US economy was
Speaker 1: actually recovering. How how big a factor do you think
Speaker 1: bank demand has been when it comes to yields. It's
Speaker 1: not it's not in the numbers. I mean, you just
Speaker 1: don't see. You just don't see any kind of level
Speaker 1: shift in in thanks buying more treasuries. So you know
Speaker 1: they will have the cold reports out in a couple
Speaker 1: of beeks, but but I doubt that there's anything increase
Speaker 1: in bank buying because you noticed from the v P
Speaker 1: a number. So you just just don't see any of that.
Speaker 1: I mean, you know, the one thing I would point
Speaker 1: to is, you know some of the there's two things.
Speaker 1: You know that it's always about clothes and technical so
Speaker 1: to speak. And then there is the narrative. I mean,
Speaker 1: you know, the delta variant get a little out of hand,
Speaker 1: and you know articles about that kind of started to
Speaker 1: percolate proughly when when yields have started to really, so
Speaker 1: I think I think a lot of this is party
Speaker 1: partlet of virus and the delta variant, but also t
Speaker 1: g A moss were coming down, right, So so all
Speaker 1: this cache was coming into the system, and when when
Speaker 1: large amounts of money are coming into the system, there's
Speaker 1: always some leakage because you know, people think about d
Speaker 1: g A comes down, so there's fewer bills. All that
Speaker 1: money goes to RP, yes, most of it, but some
Speaker 1: of it leads and so someone who was in bills
Speaker 1: probably went into an aggregant bond fund and that aggregant
Speaker 1: bond fund had to kind of deployed that money coming in,
Speaker 1: and so there was some bit for for fixed to come.
Speaker 1: So so I think I think it's a combination of
Speaker 1: those two. But it's definitely not been the bank portfolios
Speaker 1: that that caused that caused the really it was certainly
Speaker 1: not uh JP Morgan because they were kind of waiting
Speaker 1: for the others the other things to happen, you know.
Speaker 1: So Okay, well, um let's talk about the standing repo
Speaker 1: facility then. Um, you know, when the FED announced that
Speaker 1: there were a lot of different interpretations over what exactly
Speaker 1: it's meant to be doing so. You know, on the
Speaker 1: one hand, some people were saying it's supposed to prevent
Speaker 1: more blow ups in the repo market. Um. But then
Speaker 1: there were some other people who were saying, it's basically
Speaker 1: paving the way for the end of QUEI and allowing
Speaker 1: the FED to start the taper. So how are you
Speaker 1: viewing it? Yes, so, so the latter one was, you know,
Speaker 1: the view that I that I subscribed to as well, Look,
Speaker 1: we don't need a standing repo now there's so much
Speaker 1: money in the system that we won't need it for
Speaker 1: the next five years in in the aggregate sense, you know. Um,
Speaker 1: so the standing repo facility I think it's going to
Speaker 1: be I would say, we are see the impact. I mean,
Speaker 1: you have to standing people. There's one for three actually,
Speaker 1: if you want to think about its actually one is
Speaker 1: there for the dealers that should be able to replace funding.
Speaker 1: They need to mediate um between the and the cash providers.
Speaker 1: The cash providers blow away from the dealers that is
Speaker 1: going to step in and so the dealers to find
Speaker 1: standing repurposes just the term. But again I tend to
Speaker 1: think about these in terms of types events that have accessed.
Speaker 1: So there's the dealers then there will be the bank
Speaker 1: port folios large and small that can that cannot buy.
Speaker 1: And then you have the FEMA report facility, which is
Speaker 1: which is the same for for foreign central backs. So
Speaker 1: that's that's that's one one BA gold block, so to speak.
Speaker 1: I also want to say the same day that the
Speaker 1: SET announced sending report facility, the G thirty also issued
Speaker 1: a report, part of which was basically recommending that we
Speaker 1: also need a standing group of but we need to
Speaker 1: make this available to anyone who owns treasury collateral. And
Speaker 1: so there was always these two views about who should
Speaker 1: we make who should get access to the standing group,
Speaker 1: and so I always thought, you know, the the the
Speaker 1: issue with opening up for everyone is that, you know,
Speaker 1: it's just it's just a very broad system, right so
Speaker 1: you know, if it's hedge funds to how do you
Speaker 1: draw the line you're letting the little ones and the
Speaker 1: big ones. If it's asset managers, again, how do you
Speaker 1: how do you design the criteria for access and haircuts
Speaker 1: and whatnot, and so so that's cumbersome. Then if you
Speaker 1: think about what the FET did, it's actually it's actually
Speaker 1: a beautiful middle ground because you know the dealers, of
Speaker 1: course they always deal with bank portfolios and foreign central bx.
Speaker 1: What are they? I mean, they are half the by side.
Speaker 1: You know, if you think about the by side from
Speaker 1: the dealer's perspective, you know, it's the insurance companies, it's
Speaker 1: the asset managers, the hedge funds, and the bank portfolio
Speaker 1: and the foreign central banks. So basically two very important actors.
Speaker 1: From from the bias, I've got access to the sustanding
Speaker 1: pople facility, which means that in the next crisis, and
Speaker 1: there will be an ex crisis because there's always are
Speaker 1: that there always are you know, they will be able
Speaker 1: to go to the FED to turn bonds into into liquidity,
Speaker 1: whether you're a foreign center bank or a banquet bo
Speaker 1: you and that's going to be a massive help for
Speaker 1: everyone else in the system because the dealers won't have
Speaker 1: to deal with these accounts because they can go to
Speaker 1: the FED directly, and so everybody else is going to
Speaker 1: have more more balance sheet that um that the dealers
Speaker 1: can that the dealers can provide to them. So this
Speaker 1: is this is how the countours of the next basis
Speaker 1: is going to play out. Observation number one, Observation number two.
Speaker 1: You know why now look I think, I think anyone
Speaker 1: anyone that has because you're a foreign central bank, now
Speaker 1: you need sixty billion dollars less in liquidity because you
Speaker 1: know that the FED will give it to you. So
Speaker 1: if you if you if you think about the typical
Speaker 1: effects manager, it has some liquid assets in money markets,
Speaker 1: has some longer term securities and treasuries of mortgage. That
Speaker 1: that money market did is basically, you know, you just
Speaker 1: leave money on the table because that's your liquidity insurance.
Speaker 1: That's the money that you can spend on short order
Speaker 1: if something unexpected happen. You can now allocate sixty billion
Speaker 1: less UH to those types of instruments because if and
Speaker 1: when that licurity event, the feed is going to be
Speaker 1: able to provide to you that acurity on demand for
Speaker 1: a fixed price. Then you know, these liquidity events always
Speaker 1: less like a week or two weeks or a month
Speaker 1: maybe at most, and then the flows changed. But you know,
Speaker 1: it's a it's a nice it's a nice tool to have,
Speaker 1: and you can also know that you know the fet
Speaker 1: is not going to be opportunistic. You know, if not,
Speaker 1: it might not be the case if you if you
Speaker 1: want to raise the petulity in the market because you
Speaker 1: will be with dealers. Dealers can charge your price. If
Speaker 1: you're doing this, the world can get out. You know,
Speaker 1: it's it's it's not supposed to, but you know people
Speaker 1: always started like calls on accounts read one account is selling.
Speaker 1: I would I would also say that you know, this
Speaker 1: report facility, even though it's going to be more expensive
Speaker 1: than the market, because it's priced a little bit wider
Speaker 1: than the market design, there will be an an an
Speaker 1: limited premium that foreign central banks are are willing to
Speaker 1: pay up for because because they can just raise their
Speaker 1: these they're really anonymous thing. You know, if you remember
Speaker 1: China selling uh you know back sixteen all those treasuries
Speaker 1: and cause some backuping dealer in the increason what threads around.
Speaker 1: I would even say that those episodes probably are going
Speaker 1: to be less painful going forward because you just go
Speaker 1: to the FED and so instead of selling those treasuries
Speaker 1: into spine and stand, get those dollars to your interventions
Speaker 1: in the in the in the in the local currency market.
Speaker 1: So so I think this is this is going to
Speaker 1: smooth things. I would also say since the standing report
Speaker 1: facility was announced, we've had a ten year auction and
Speaker 1: a five year auction that has gone extremely you know,
Speaker 1: well especially the ten uere auction, and we've seen a
Speaker 1: foreign participation at those and at those auctions so which
Speaker 1: was a record participation by foreign official accounts. So so
Speaker 1: I think here's a liquidity tool, and the foreign center
Speaker 1: banks are saying thank you, and they are are underwriting
Speaker 1: the deficits the resultant. You know, if you think about
Speaker 1: five large central banks each allocating sixty billion dollars experts treasuries,
Speaker 1: that's that's three hundred billion dollars, don't know, half a
Speaker 1: taper or something like that. So you know, foreign central banks,
Speaker 1: I think over time they will change their behavior all
Speaker 1: the little less security and lend a little longer to
Speaker 1: the US government because the other arm of the U.
Speaker 1: S Government is going to fund their liquidity. So that's
Speaker 1: that's fun. The bank portfolios to be able to apply
Speaker 1: starting at piver one for for access to this facility,
Speaker 1: and you know, the bank portfolios, I think, I think
Speaker 1: this is not going to be as big a deal
Speaker 1: for for the big banks like Japer, Morgan and Bank
Speaker 1: of America because because they are they are a league
Speaker 1: of their own. But you know, there is twenty thirty
Speaker 1: or so regional banks, smaller banks that also will qualify.
Speaker 1: Then I think it's an overlooked fact that a lot
Speaker 1: of these smaller banks also have a lot of access
Speaker 1: reserves that they accumulated over the past years. Um. I
Speaker 1: think I think that number. Um, I don't have it
Speaker 1: on top of my head, but it's something like four
Speaker 1: billion dollars. They can also spend some of these activity
Speaker 1: on treasury securities and mortgages because they know that, you know,
Speaker 1: the fat is there at twenty five pass points, Chances
Speaker 1: are I will never need that activity, right, So if
Speaker 1: there's a spread in buying treasuries, you should just you
Speaker 1: should just do that. So so so I think this
Speaker 1: is going to move the needle a lot, uh in
Speaker 1: terms of making treasuries collateral in general, more attractive, more
Speaker 1: attractive than cash, which is again if you look at
Speaker 1: the side, guys, that's precisely that's precisely what you need.
Speaker 1: This is this is generating demand. This is generating demand
Speaker 1: for for for treasury securities from two very important buyers. Yeah,
Speaker 1: this is something I wanted to ask you about because
Speaker 1: there was this concern around who will actually buy treasury
Speaker 1: securities and agency mbs. So you know, mortgage bonds issued
Speaker 1: by the g s c s when the FED starts
Speaker 1: to taper QUEI and you're suggesting that it's I guess
Speaker 1: a non issue now because of the standing repot facility.
Speaker 1: Is that right? Yes? I think this is a This
Speaker 1: is the question of who will buy is a very
Speaker 1: important question um in retrospect. Who buys on the margin.
Speaker 1: It's it's always very simple, you know, like but in
Speaker 1: real time and you need to figure out who's going
Speaker 1: to buy in the next Uh. That's what people, you know, confused.
Speaker 1: It's just kind of hard to be But look, if
Speaker 1: we were to tell here's a brief history of of
Speaker 1: rates and funding markets for the past five years, okay,
Speaker 1: and it's you know, we always talked about the marginal
Speaker 1: buyer in this program because you know, like life is
Speaker 1: on the margin. Everything in market margin, So who's the
Speaker 1: marginal buyer? Twenty to twenty seventeen, it was the Asian
Speaker 1: fects hedged buyers that were extremely important and and we're closed.
Speaker 1: So they were buying the treasuries they were sparking and
Speaker 1: for dollars. Europeans were doing the same, and so that
Speaker 1: that that they were the marginal buyers and then the
Speaker 1: prose curency bass blew out and then they you know,
Speaker 1: had their trial by fires there. Demand kind of changed
Speaker 1: a little bit after that. Then you had a bond
Speaker 1: basis that opened up. The set started to creates the
Speaker 1: curve gradually platin so it's it was all the r
Speaker 1: V hedge funds um and they funded everything in the
Speaker 1: repo markets. And then we had that repo market episode
Speaker 1: in September. The FEDS started to rebuild the liquidity buffer
Speaker 1: of the system that build purchases and Lemic came and basically,
Speaker 1: you know that was that was a moment where even
Speaker 1: though you were building up the licurity buffer of the
Speaker 1: system and you were going back to this access reserves regime,
Speaker 1: you didn't do it fast enough, and the pandemic forced
Speaker 1: your hand and basically the feed needed to take out
Speaker 1: all the all the r V hedge funds from these
Speaker 1: bond based positions because they couldn't fund fund these positions.
Speaker 1: And then and then the bank portfolio stepped in and
Speaker 1: they became the dominant buyers of treasury. So this is
Speaker 1: the span of six years. You know, foreign fex hedge
Speaker 1: to counts funding in the FEX bod market, relative value,
Speaker 1: hedge funds funding in the report market. Um. And now
Speaker 1: we have you know, the bank portfolios supported with a
Speaker 1: standing report facility in case there is a need for it,
Speaker 1: and so who is going to buy going forward? I
Speaker 1: think I think the bank portfolios will be a very
Speaker 1: important part of the picture because that's where the excess
Speaker 1: cash is. We we just basically broadened and incentivized slightly
Speaker 1: broader set of banks and foreign central banks to do
Speaker 1: the same that that JP Morgan and Bank of America
Speaker 1: have been doing ever since the beginning of the pandemic.
Speaker 1: So so I think we are we are basically puttering
Speaker 1: up and and appealing to a certain buyer base. That's
Speaker 1: that's that's going to be doing the bidding of the government.
Speaker 1: And also keep in mind, you know, we are also
Speaker 1: in an environment where loan loan demand is very weak
Speaker 1: and a bank needs to land that the bank bank
Speaker 1: has has has capital, and that that needs to be deployed.
Speaker 1: And so I think and another another very important thing
Speaker 1: to keep in mind is that when you think about
Speaker 1: the lending process, you know, a bank makes a loan
Speaker 1: to be it's the past, it's the kind of tradition
Speaker 1: that's the way things supposed to work. I guess that's traditional.
Speaker 1: But the other version of this is a bank pis
Speaker 1: of treasury security and creates a deposit when they when
Speaker 1: they do that, and it's and the and then the
Speaker 1: government is going to spend all that moody. So if
Speaker 1: you think about this infrastructure built, for example, you know,
Speaker 1: normally it's all the private sector building stuff. But when
Speaker 1: the private sector is building stuff, you know, some developer
Speaker 1: goes to a bank. You know, you want to build
Speaker 1: HUDs And Yards, you go to a bank, you take
Speaker 1: out of finances, okay, And so the bank made alone,
Speaker 1: created a deposit, and the developer of Hudson Yards is
Speaker 1: going to spend it to all the contractors. And so
Speaker 1: that's what that looks like on the balance sheet of
Speaker 1: the banking system. If it's the government doing infrastructure projects,
Speaker 1: they will borrow the money and they will send it
Speaker 1: to the little contractors to build whatever. So then all
Speaker 1: of a sudden, it's not loan deposits, but it's treasury
Speaker 1: securities the deposits. And probably we will see a lot
Speaker 1: more of this type of lending going forward than we
Speaker 1: have seen. You know, this pure form of the old
Speaker 1: old type of landing which is all which is all
Speaker 1: loan based, you know, this is this is basically the
Speaker 1: future I think. I think the banks will be buying
Speaker 1: a lot more treasuries and and a lot more mortgage
Speaker 1: backed securities, and the fact that this strip of facility
Speaker 1: is there to help in occasional liquidity hiccups, uh without
Speaker 1: a stigma. I think I think it's going to be
Speaker 1: a huge incentive. It's always about incentives, you know. Again
Speaker 1: in retrospect, it's always simple, as I said, over the
Speaker 1: past five years, were the most important marginal buyers that
Speaker 1: were going forward, it will be the banks, And that
Speaker 1: means that it's also going to be a very stable
Speaker 1: form of funding government because it's all going to be
Speaker 1: sticky deposits. So I'm a little bit concerned, just from
Speaker 1: a a very like self interested financial journalist perspective, that
Speaker 1: you're laying out a financial system that seems quite smooth
Speaker 1: and seems like kind of unlikely to end up in
Speaker 1: a massive blow up that you know, someone like me
Speaker 1: can write lots of articles about um which in some ways,
Speaker 1: you know, money markets and the repo market was always
Speaker 1: supposed to be a boring area of the financial system
Speaker 1: that just worked, but then it exploded in two thousand
Speaker 1: and eight, and then we've had various explosions since then.
Speaker 1: Is there anything interesting coming up in in Repo that
Speaker 1: we should be watching out for, like, you know what
Speaker 1: what should be getting us excited? Because you've described it
Speaker 1: as this beautiful system and very smooth in terms of functioning. Yes, um, well,
Speaker 1: as as I said it, it's quite depressing in my market. Um.
Speaker 1: And you know, just just like you would like to
Speaker 1: write about interesting things. You know, people want to put
Speaker 1: on put on trades about you know, spread though ups
Speaker 1: and whatnot. Um, yes, look you're right. I mean you know,
Speaker 1: the the Dealer of Last Resort was missing from the
Speaker 1: picture institutional, you know, like that's why we had that
Speaker 1: September Time nineteen episode. Um, the spot lines are now
Speaker 1: there standing, people cilities there, and the FET is doing
Speaker 1: this dealer of last Resort thing on both sides of
Speaker 1: its balianship. Right, So the FET is keeping interest rates
Speaker 1: from going too low with the reversaryport facility. It's it's
Speaker 1: keeping reports from gowerring too high. And and you know
Speaker 1: the FX spot market from from from blowing up the
Speaker 1: spot lines and so yes, this is a very this
Speaker 1: is a very stable era of the system. I would
Speaker 1: say that we are we are looking forward to but
Speaker 1: but but I would also say that, you know, this
Speaker 1: was a five year learning process of the FED, right
Speaker 1: because what were the past five years about the past
Speaker 1: five years were about. You know, we had financial reform,
Speaker 1: we had Basil three, bank balance spits are less flexible,
Speaker 1: you know, uh, you know, all all the things that
Speaker 1: happened over the past five years. And so the FED
Speaker 1: was still thinking. I would say that the Great Financial
Speaker 1: Crisis was a it was a one off, and the
Speaker 1: things we had to do then hopefully they will never
Speaker 1: have to do again. And so here we are today
Speaker 1: where some of the things that the set they during
Speaker 1: your Great Financial crisis, some of the things that the
Speaker 1: FED did last March March, they became institutionalized and they
Speaker 1: are now standing facilities. So they are definitely going to
Speaker 1: take the edge off of of a funding markets. And
Speaker 1: so whether this is good or bad, what this means
Speaker 1: is that the frontier is shifting elsewhere because whatever problems
Speaker 1: they will have is probably going to happen and in
Speaker 1: some in some other jurisdiction. But I think dollar funding
Speaker 1: markets are are are are going to be much more stable,
Speaker 1: much more stable going forward. Things will be very quiet
Speaker 1: until we get to a point where the banking system
Speaker 1: again is liability constraints because there's just so much cash
Speaker 1: in the system that you know, the banks you're not
Speaker 1: going to have any problem funding problems to the foreseeable future.
Speaker 1: And you know, as band Bernanke said at the end
Speaker 1: of the first three Qui episodes, you know, the first
Speaker 1: balance is very big, and over time the economy and
Speaker 1: the banking system is going to grow into this big
Speaker 1: balance shot. I think in a similar vein is probably
Speaker 1: going to take a few more in in in treasury
Speaker 1: securities and in a few more trillions. It's before before
Speaker 1: all this access access cash gets get soaked up. But
Speaker 1: again once that, once that type type security environment arrives,
Speaker 1: I think abouts and suspenders around how we are going
Speaker 1: to deal with that types are are indeed just going
Speaker 1: to to make things um less, less spectacular and spread
Speaker 1: the while still be less spectacular than they were. It's
Speaker 1: been benefiting and and and the beginning of the pandemic.
Speaker 1: I think it's an end of an era. Yeah, it
Speaker 1: sounds like a much more boring system awaits us a
Speaker 1: less spectacular system Sulton, it's great having you on as always.
Speaker 1: Thank you so much. Okay, thank thanks for thanks for thanking.
Speaker 1: So i' don't have that much to add to what
Speaker 1: Salton just said, And of course it's always weird doing
Speaker 1: this when I'm basically talking to myself, but I do
Speaker 1: think the end of an era idea is an interesting one,
Speaker 1: and it does feel like we've seen a sort of
Speaker 1: step change in the repo market, given that we now
Speaker 1: have these two facilities. As Alton said, you have the
Speaker 1: reverse repot facility that is putting a floor under rates,
Speaker 1: and then you have the standing facility that's basically putting
Speaker 1: a ceiling on rates, And it just feels like, I
Speaker 1: don't know, the system is going to be much more
Speaker 1: constrained or much more controlled, much more steady going forward.
Speaker 1: So I guess we'll have to wait and see what happens. Um.
Speaker 1: You know, with a new system, there's always the chance
Speaker 1: that you do see new risks develop. Um, So maybe
Speaker 1: there's something out there that no one has seen yet
Speaker 1: and we will get a chance to write something about
Speaker 1: it one day. Okay, this has been another episode of
Speaker 1: the All Thoughts podcast. I'm Tracy Alloway. You can follow
Speaker 1: me on Twitter at Tracy Alloway. Joe isn't here, but
Speaker 1: of course you can follow him on Twitter at The Stalwart.
Speaker 1: You can also follow our producer Laura Carlson at Laura M. Carlson.
Speaker 1: And you can follow Bloomberg's head of podcast Francesco Levi
Speaker 1: at Francesca Today. Thanks for listening.