1 00:00:10,920 --> 00:00:14,240 Speaker 1: Hello, and welcome to another episode of the Odd Thoughts Podcast. 2 00:00:14,280 --> 00:00:17,880 Speaker 1: I'm Chracy Allowin and I'm Joe. Joe. You know it 3 00:00:17,960 --> 00:00:23,640 Speaker 1: just happened. It's a very very open ended question, so 4 00:00:24,760 --> 00:00:30,400 Speaker 1: I need to tell me what happened. Alright, So let's 5 00:00:30,440 --> 00:00:33,800 Speaker 1: see a couple of weeks ago. It not only was 6 00:00:33,920 --> 00:00:38,159 Speaker 1: the end of the first quarter, uh it was the 7 00:00:38,280 --> 00:00:41,760 Speaker 1: end of March. It was also the end of the 8 00:00:41,880 --> 00:00:46,800 Speaker 1: fiscal year for a lot of big Asia investors, specifically 9 00:00:47,000 --> 00:00:49,479 Speaker 1: Japanese banks. I know that is the highlight of your 10 00:00:49,520 --> 00:00:52,640 Speaker 1: calendar every year. Did you celebrate? I like, do people 11 00:00:52,760 --> 00:00:56,160 Speaker 1: out there do a fiscal New Year's celebration? I mean, 12 00:00:56,200 --> 00:00:58,960 Speaker 1: I know there's a lot of finance out there in 13 00:00:59,080 --> 00:01:01,240 Speaker 1: Hong Kong, and so is that a thing out there 14 00:01:01,320 --> 00:01:05,039 Speaker 1: or is that just it's not the same? Uh I. 15 00:01:05,040 --> 00:01:09,039 Speaker 1: I confess that I didn't notice anyone um celebrating more 16 00:01:09,080 --> 00:01:11,680 Speaker 1: than usual. I did write a high ku on Twitter, though, 17 00:01:12,400 --> 00:01:16,240 Speaker 1: and my high ku, my high ku was about stress 18 00:01:16,280 --> 00:01:19,679 Speaker 1: in the money markets, which is something that occasionally happens 19 00:01:19,800 --> 00:01:23,520 Speaker 1: at quarter ends. That there's been a thing lately and 20 00:01:23,640 --> 00:01:25,720 Speaker 1: people are sort of in the final few days of 21 00:01:25,800 --> 00:01:28,279 Speaker 1: the final week or a couple of weeks of the quarter, 22 00:01:28,680 --> 00:01:31,360 Speaker 1: you start to hear people rumbling about, are we gonna 23 00:01:31,400 --> 00:01:35,120 Speaker 1: see um see stress appearing in various money market and 24 00:01:35,120 --> 00:01:39,000 Speaker 1: fixed income markets, And I feel like I don't have 25 00:01:39,560 --> 00:01:44,160 Speaker 1: my head completely wrapped around why this keeps happening. Ah, well, 26 00:01:44,200 --> 00:01:46,280 Speaker 1: then I know just the person who's going to be 27 00:01:46,319 --> 00:01:49,360 Speaker 1: able to help you with this. But yes, essentially, Uh, 28 00:01:49,480 --> 00:01:53,120 Speaker 1: let's see at right before the year end, right before 29 00:01:53,160 --> 00:01:55,240 Speaker 1: December thirty first last year, we did see a bunch 30 00:01:55,240 --> 00:01:58,480 Speaker 1: of people talking about funding stress in the money market, 31 00:01:58,560 --> 00:02:01,520 Speaker 1: which is just about the biggest money market that you 32 00:02:01,560 --> 00:02:03,960 Speaker 1: can think of. And then just at the end of 33 00:02:04,000 --> 00:02:08,080 Speaker 1: the first quarter we saw that yet again. So something 34 00:02:08,200 --> 00:02:11,800 Speaker 1: is clearly happening in the market. At the same time, 35 00:02:11,919 --> 00:02:15,280 Speaker 1: a big component of the money market, uh, something that 36 00:02:15,400 --> 00:02:18,200 Speaker 1: is often used as collateral for the money market. US 37 00:02:18,280 --> 00:02:24,919 Speaker 1: treasuries are also undergoing massive, massive changes, some of which 38 00:02:25,160 --> 00:02:27,840 Speaker 1: you might have picked up on in the US. Once again, 39 00:02:28,000 --> 00:02:30,079 Speaker 1: I feel like this is an area in which I'm 40 00:02:30,160 --> 00:02:33,240 Speaker 1: extremely weak on, like a lot of the sort of 41 00:02:34,000 --> 00:02:37,160 Speaker 1: the deep plumbing of the financial system I wish I 42 00:02:37,240 --> 00:02:40,919 Speaker 1: knew more about, and I'm I'm optimistic that maybe I'll 43 00:02:41,000 --> 00:02:44,520 Speaker 1: learn more after today's episode, Joe, I know you know this, 44 00:02:44,639 --> 00:02:47,040 Speaker 1: So you know the U. S. Treasury is selling basically 45 00:02:47,120 --> 00:02:54,080 Speaker 1: a record point thank you? Okay, a few Okay. So 46 00:02:54,120 --> 00:02:55,960 Speaker 1: at the same time that the U. S. Treasury is 47 00:02:56,000 --> 00:02:58,760 Speaker 1: selling a lot of debt, we have a bunch of 48 00:02:58,840 --> 00:03:01,799 Speaker 1: changes sort of taking places in the underlying money market, 49 00:03:01,880 --> 00:03:04,120 Speaker 1: and we're going to discuss all of those with someone 50 00:03:04,160 --> 00:03:08,840 Speaker 1: who is really the foremost expert on this topic. So 51 00:03:08,880 --> 00:03:11,720 Speaker 1: I'm very pleased that our guest for this particular episode 52 00:03:11,760 --> 00:03:15,079 Speaker 1: is Reultan Posar. He's a strategist over at Credit Swiss. 53 00:03:15,120 --> 00:03:18,639 Speaker 1: He's also a former US Treasury advisor, So who better 54 00:03:18,800 --> 00:03:21,880 Speaker 1: to talk about the massive changes underway not only in 55 00:03:21,880 --> 00:03:24,120 Speaker 1: money markets but also in the U. S. Treasury market 56 00:03:24,400 --> 00:03:26,360 Speaker 1: result in, it's so good to have you on the show. 57 00:03:26,919 --> 00:03:29,960 Speaker 1: Thank you very much for having me. So I sort 58 00:03:30,000 --> 00:03:33,639 Speaker 1: of alluded to this, uh in the intro, but we're 59 00:03:33,639 --> 00:03:36,240 Speaker 1: going to be talking about money markets and and just 60 00:03:36,320 --> 00:03:40,840 Speaker 1: to back up for Joe's benefit, obviously, can you tell 61 00:03:40,920 --> 00:03:44,880 Speaker 1: us what is your concept of money markets? What are 62 00:03:44,880 --> 00:03:47,520 Speaker 1: we talking about when we say the money market? Thank you. 63 00:03:47,560 --> 00:03:49,760 Speaker 1: I'm glad you asked this and didn't skip over this 64 00:03:49,840 --> 00:03:54,640 Speaker 1: question because I would have. Yes, money markets, I think 65 00:03:55,760 --> 00:04:00,560 Speaker 1: in my inserprevision, I think anything from overnight and introduced 66 00:04:00,600 --> 00:04:04,320 Speaker 1: stuff out to I would say three months. And so 67 00:04:04,400 --> 00:04:10,040 Speaker 1: that's the core of it. And you know money markets 68 00:04:10,040 --> 00:04:13,360 Speaker 1: are hierarchical, and that that shows up in you know, 69 00:04:13,480 --> 00:04:16,279 Speaker 1: the term aspect of it, the institutional aspect of it, 70 00:04:16,360 --> 00:04:18,520 Speaker 1: the instrumental aspect of it. But I think the core 71 00:04:18,560 --> 00:04:21,760 Speaker 1: of it is definitely all the flows that happened in 72 00:04:21,760 --> 00:04:25,919 Speaker 1: the financial system three months and in so very short 73 00:04:26,040 --> 00:04:31,359 Speaker 1: term funding. And the people who are buying and selling 74 00:04:31,440 --> 00:04:35,680 Speaker 1: this short term funding, they're basically rolling over it constantly 75 00:04:35,880 --> 00:04:39,120 Speaker 1: right in in the overnight market usually or through the 76 00:04:39,160 --> 00:04:42,840 Speaker 1: repo market where they sort of use the underlying securities 77 00:04:43,000 --> 00:04:46,839 Speaker 1: as collateral to secure extra financing. Yes, so so there 78 00:04:46,960 --> 00:04:50,400 Speaker 1: is there is various types of players. Um, maybe we 79 00:04:50,440 --> 00:04:54,719 Speaker 1: can start from outside in so you have you know, 80 00:04:54,720 --> 00:04:56,719 Speaker 1: I guess the the every time you think about a 81 00:04:56,760 --> 00:05:00,680 Speaker 1: carry trader, whoever is buying a bond and financing it 82 00:05:01,160 --> 00:05:05,080 Speaker 1: short in the short term money markets. You know, Perry 83 00:05:05,120 --> 00:05:08,479 Speaker 1: Merlin would say that they do money market funding of 84 00:05:08,560 --> 00:05:13,400 Speaker 1: capital market landing another way of saying, shadow banking, carry trading, 85 00:05:13,600 --> 00:05:16,880 Speaker 1: all that stuff. Uh, that typically gets funded at the 86 00:05:16,880 --> 00:05:22,279 Speaker 1: three month point, simply because most bonds paid coupons every 87 00:05:22,400 --> 00:05:25,160 Speaker 1: quarter and so it's convenient. I guess it's just an 88 00:05:25,200 --> 00:05:28,719 Speaker 1: industry convention. So if you are someone who is not 89 00:05:28,760 --> 00:05:32,080 Speaker 1: a dealer and who's not a bank, you will tend 90 00:05:32,160 --> 00:05:37,520 Speaker 1: to fund the three month points. And there are obviously 91 00:05:37,520 --> 00:05:40,159 Speaker 1: any other end of the spectrum. You have players that 92 00:05:40,279 --> 00:05:44,440 Speaker 1: fund overnight. Those would be banks and dealers that have 93 00:05:44,960 --> 00:05:50,159 Speaker 1: a deeper ability to roll this financing every day. And 94 00:05:50,200 --> 00:05:52,560 Speaker 1: then the arbit treasures, I would say in the money 95 00:05:52,600 --> 00:05:55,680 Speaker 1: market live between the overnight point and a three month point, 96 00:05:56,600 --> 00:05:59,479 Speaker 1: because some of these arbitrast trades are about, you know, 97 00:05:59,560 --> 00:06:01,719 Speaker 1: borrowing money for one months and lending it at the 98 00:06:01,720 --> 00:06:06,040 Speaker 1: three month point and rolling it every three months I'm sorry, 99 00:06:06,080 --> 00:06:08,760 Speaker 1: every month, or if you want to do shorter arm 100 00:06:08,839 --> 00:06:11,720 Speaker 1: you can do one week to one month and one 101 00:06:11,800 --> 00:06:14,400 Speaker 1: day to one week. And so you know, the three 102 00:06:14,400 --> 00:06:16,919 Speaker 1: months and the overnight points are the extremes and and 103 00:06:17,040 --> 00:06:20,120 Speaker 1: the large gesips or whatever you want to call them 104 00:06:20,160 --> 00:06:22,520 Speaker 1: these days, they are the ones that move the money 105 00:06:22,560 --> 00:06:24,680 Speaker 1: between the overnight point and the three month point. But 106 00:06:24,720 --> 00:06:28,000 Speaker 1: all these ending that end users of funding tend to 107 00:06:28,080 --> 00:06:31,599 Speaker 1: live at the three month points. So all these different 108 00:06:31,640 --> 00:06:35,960 Speaker 1: players are engaged in different transactions, but essentially if they're 109 00:06:35,960 --> 00:06:39,200 Speaker 1: borrowing at very short term rate for some sort of 110 00:06:39,279 --> 00:06:42,960 Speaker 1: further trade, whether it's a lending or buying some bond 111 00:06:43,440 --> 00:06:46,400 Speaker 1: out there that has a higher yield, how big and 112 00:06:46,440 --> 00:06:49,359 Speaker 1: hoping the profit from the spread? How big is the 113 00:06:49,400 --> 00:06:52,599 Speaker 1: money market? I mean, it's huge. It's uh, I never 114 00:06:52,680 --> 00:06:55,800 Speaker 1: counted it. It's probably north of five trillion dollars. And 115 00:06:55,839 --> 00:06:59,880 Speaker 1: then if you just look at the the large groups 116 00:06:59,880 --> 00:07:02,479 Speaker 1: of investors that borrow in it, I mean the most 117 00:07:02,520 --> 00:07:07,000 Speaker 1: obvious investor example is governments. The U S. Treasury they 118 00:07:07,080 --> 00:07:11,440 Speaker 1: have um, you know, trillions of bills outstanding. You have 119 00:07:11,680 --> 00:07:14,080 Speaker 1: the large banks, all of which now have to fund 120 00:07:14,640 --> 00:07:18,000 Speaker 1: their so called h qul A portfolios around the three 121 00:07:18,040 --> 00:07:22,240 Speaker 1: month points, so that's that's another trillion. You have the 122 00:07:22,280 --> 00:07:25,480 Speaker 1: federal homeland banks in the US, which issue easily a 123 00:07:25,600 --> 00:07:30,560 Speaker 1: trillion dollars um. The report market, we have daily statistics 124 00:07:30,560 --> 00:07:33,320 Speaker 1: on it. It's at least a trillion dollars only at 125 00:07:33,320 --> 00:07:35,320 Speaker 1: the overnight point, and the most of the report market 126 00:07:35,400 --> 00:07:38,240 Speaker 1: is overnight anyway, So I think that's that's already around 127 00:07:38,280 --> 00:07:41,800 Speaker 1: five trillion. And then The thing that's unmeasured, but it's 128 00:07:41,920 --> 00:07:44,520 Speaker 1: very important and very huge is the f FX swap market, 129 00:07:45,120 --> 00:07:47,840 Speaker 1: which is, you know, people think of it as a 130 00:07:47,880 --> 00:07:50,600 Speaker 1: derivative and whatnot, but I mean, at the core of it, 131 00:07:50,600 --> 00:07:54,120 Speaker 1: it's it's really a funding market. One thing we know 132 00:07:54,280 --> 00:07:58,200 Speaker 1: is that in Tokyo alone, the dollar yen f swap 133 00:07:58,280 --> 00:08:01,960 Speaker 1: market UM is roughly one and a half trillion dollars 134 00:08:01,960 --> 00:08:05,120 Speaker 1: in size, or that's what it used to be at 135 00:08:05,200 --> 00:08:08,280 Speaker 1: least UM through the end of twenty eighteen. The Bank 136 00:08:08,320 --> 00:08:12,119 Speaker 1: of Japan they have a wonderful Financial Stability Report UM, 137 00:08:12,200 --> 00:08:15,120 Speaker 1: and there's a chart they used to publish there where 138 00:08:15,120 --> 00:08:20,640 Speaker 1: they broke down UH life insurers UM and large megabanks 139 00:08:20,720 --> 00:08:23,520 Speaker 1: demand for dollars in the f S pop market UH 140 00:08:23,560 --> 00:08:25,760 Speaker 1: and recently they stopped publishing it, but up to the 141 00:08:25,760 --> 00:08:28,360 Speaker 1: point where they published that those numbers were north of 142 00:08:28,360 --> 00:08:30,680 Speaker 1: a trillion dollars. And you know, the f FX spop 143 00:08:30,720 --> 00:08:33,960 Speaker 1: market is big, not only in Tokyo, but also in 144 00:08:34,000 --> 00:08:37,400 Speaker 1: Europe and in uh in you know Satellite Europe as 145 00:08:37,400 --> 00:08:41,600 Speaker 1: I call it, you know, Switzerland, Scandinavia, all these other places. 146 00:08:41,640 --> 00:08:45,640 Speaker 1: So I think the money market is easily north of 147 00:08:45,720 --> 00:08:49,040 Speaker 1: five chillion probably even seven trillion dollars, all right, So 148 00:08:49,080 --> 00:08:51,839 Speaker 1: it's it's a big market to say the least. There 149 00:08:51,880 --> 00:08:54,520 Speaker 1: are going to be a lot of super relatives used 150 00:08:54,559 --> 00:08:57,240 Speaker 1: in this particular chat. But Salton, I'm glad you mentioned 151 00:08:57,280 --> 00:08:59,560 Speaker 1: the f X swap market. So this is basically the 152 00:08:59,559 --> 00:09:05,520 Speaker 1: place where big investors hedge or convert their currencies. So 153 00:09:05,600 --> 00:09:08,880 Speaker 1: you know, if you're buying US dollar debt and you're 154 00:09:09,080 --> 00:09:12,600 Speaker 1: a Japanese investor, you probably don't want to be exposed 155 00:09:12,600 --> 00:09:16,160 Speaker 1: to that currency risk, so you might do a swap 156 00:09:16,280 --> 00:09:19,960 Speaker 1: um in the market to sort of offset that cost. Now, 157 00:09:20,120 --> 00:09:22,920 Speaker 1: you argue that a lot of the flows that we've 158 00:09:22,920 --> 00:09:27,720 Speaker 1: seen in money markets recently have been changing partly because 159 00:09:27,800 --> 00:09:30,040 Speaker 1: of what's going on in the f X swap market. 160 00:09:30,120 --> 00:09:34,200 Speaker 1: Can you explain that there's obviously always two sides of 161 00:09:34,360 --> 00:09:36,560 Speaker 1: the same coin, right, So on the one hand, if 162 00:09:36,600 --> 00:09:41,400 Speaker 1: you are a foreign investor, like a Japanese investor who 163 00:09:41,440 --> 00:09:44,560 Speaker 1: buys dallar assets, it's not only that you don't want 164 00:09:44,600 --> 00:09:47,360 Speaker 1: to have that dollar f X exposure, it's not in 165 00:09:47,400 --> 00:09:51,839 Speaker 1: your mandate to run with that risk, right, So by 166 00:09:51,920 --> 00:09:55,440 Speaker 1: mandate you basically have to manage the FX risk of 167 00:09:55,520 --> 00:09:58,280 Speaker 1: that position. And eliminate it. And that's what you use 168 00:09:58,320 --> 00:10:01,839 Speaker 1: the swap market for. And it's been, uh, it's been 169 00:10:01,880 --> 00:10:05,120 Speaker 1: the case that for many years the primary destination for 170 00:10:05,160 --> 00:10:08,080 Speaker 1: all these and again let's just you know, broaden this out, 171 00:10:08,120 --> 00:10:10,560 Speaker 1: so this is not just about the Japanese life insurers. 172 00:10:10,559 --> 00:10:14,360 Speaker 1: This is about Swiss life insurers, Swedish life insurers, Northern 173 00:10:14,400 --> 00:10:18,920 Speaker 1: European UH long only pension funds and and and insurers. 174 00:10:18,920 --> 00:10:23,480 Speaker 1: Whoever is basically trying to escape a negative rate jurisdiction 175 00:10:23,520 --> 00:10:27,160 Speaker 1: at home has been playing a game where they have 176 00:10:27,240 --> 00:10:33,200 Speaker 1: been looking for UH decently yielding assets, primarily in the 177 00:10:33,320 --> 00:10:36,840 Speaker 1: US UH and then buying those assets and hedging it 178 00:10:36,880 --> 00:10:40,160 Speaker 1: back to the local currency. And for as long as 179 00:10:40,200 --> 00:10:44,000 Speaker 1: the curve treasury curve was steep in the US, that 180 00:10:44,080 --> 00:10:47,199 Speaker 1: was an easy trade, right because if you could buy 181 00:10:47,240 --> 00:10:51,040 Speaker 1: the tenure treasury at two and a half percent and 182 00:10:51,080 --> 00:10:56,080 Speaker 1: pay UM one percent to hedge, the f X component 183 00:10:56,200 --> 00:10:58,480 Speaker 1: of that of that bondy would still end up with 184 00:10:58,520 --> 00:11:01,400 Speaker 1: one and a half percent, which compared to negative rates 185 00:11:01,400 --> 00:11:05,800 Speaker 1: in the in the home country are great. UM. And 186 00:11:05,880 --> 00:11:08,640 Speaker 1: you know, if you go back to twenty fifteen, that's 187 00:11:08,679 --> 00:11:11,520 Speaker 1: been that's been the case. There were a couple of 188 00:11:12,120 --> 00:11:15,199 Speaker 1: structural things that happened. I mean, number one, basiltry was 189 00:11:15,240 --> 00:11:19,160 Speaker 1: obviously introduced, and that raised balance sheet costs for all 190 00:11:19,200 --> 00:11:23,520 Speaker 1: the intermediaries that we're providing these effects edges to to 191 00:11:23,679 --> 00:11:26,880 Speaker 1: the life insurance the world over. And then we had 192 00:11:26,880 --> 00:11:30,920 Speaker 1: a couple of episodes of financial reform, like money fund reform, 193 00:11:31,120 --> 00:11:38,040 Speaker 1: like tax reform, which messed around with the spread that uh, 194 00:11:38,200 --> 00:11:40,600 Speaker 1: these foreign investors had to pay over O I s, 195 00:11:41,559 --> 00:11:44,679 Speaker 1: which is basically the feds preferred path for short term 196 00:11:44,760 --> 00:11:50,360 Speaker 1: rates UM. And and you know, sometimes these spreads periodically 197 00:11:50,360 --> 00:11:54,120 Speaker 1: flared up and they raised hedging costs, but then hedging 198 00:11:54,160 --> 00:11:58,520 Speaker 1: costs came back down after um. You know, these episodic 199 00:11:58,559 --> 00:12:01,719 Speaker 1: storms have subsided. But the very important thing that has 200 00:12:01,760 --> 00:12:06,040 Speaker 1: happened from twenty seventeen onwards is that the FED really 201 00:12:06,080 --> 00:12:09,160 Speaker 1: started to hike interest rates. And as the FED started 202 00:12:09,160 --> 00:12:13,520 Speaker 1: to hike interest rates, they flattened the curve completely. So basically, 203 00:12:14,520 --> 00:12:19,280 Speaker 1: relative to three month bills, the tenure treasury barely yielded 204 00:12:20,040 --> 00:12:22,680 Speaker 1: a lot more. And then when you add up these 205 00:12:22,760 --> 00:12:25,720 Speaker 1: post basal three spreads on top of very elevated front 206 00:12:25,800 --> 00:12:28,080 Speaker 1: and rates, you basically ended up in a situation that 207 00:12:28,280 --> 00:12:31,560 Speaker 1: where if you're a foreign investor, you just cannot buy 208 00:12:31,600 --> 00:12:37,479 Speaker 1: treasuries on a hedged basis and make a positive spread. Okay, 209 00:12:37,640 --> 00:12:40,720 Speaker 1: And you know, this has also been a theme that's 210 00:12:40,720 --> 00:12:44,079 Speaker 1: been going on for a while. And because treasuries were 211 00:12:44,080 --> 00:12:48,199 Speaker 1: no longer attractive given hedging costs, another important theme in 212 00:12:48,240 --> 00:12:50,600 Speaker 1: the US has been that all of the foreign flow 213 00:12:50,640 --> 00:12:53,720 Speaker 1: has been going into the credit markets, anything from I 214 00:12:53,920 --> 00:12:56,560 Speaker 1: G to high yield to c l os. So obviously 215 00:12:56,600 --> 00:13:01,520 Speaker 1: that that helped, UH strong conditions in those markets, and 216 00:13:01,800 --> 00:13:05,760 Speaker 1: you know, those assets trade at a reasonably you know, 217 00:13:05,840 --> 00:13:09,800 Speaker 1: widespread the treasuries, and those widespreads were basically what offset 218 00:13:09,840 --> 00:13:16,040 Speaker 1: the rising hedging costs. Do these uh foreign institutional investors 219 00:13:16,400 --> 00:13:19,840 Speaker 1: um And you mentioned earlier that currency risk was not 220 00:13:19,960 --> 00:13:23,480 Speaker 1: part of their mandate, How does the credit risk of 221 00:13:23,960 --> 00:13:27,120 Speaker 1: buying corporates fit into their mandate? Credit risk is fine, 222 00:13:27,520 --> 00:13:30,160 Speaker 1: that's no problem for them, right because you know, the 223 00:13:30,360 --> 00:13:33,280 Speaker 1: thing about FX pop market, the FX markets is that 224 00:13:33,360 --> 00:13:35,680 Speaker 1: you know, currency is gonna can go up and down, 225 00:13:35,840 --> 00:13:40,600 Speaker 1: you know, five fairly easily. I think in the credit world, 226 00:13:40,600 --> 00:13:45,640 Speaker 1: if you don't have anything systemic or anything sector specific, 227 00:13:45,679 --> 00:13:47,600 Speaker 1: and for as long as you're diversified, and I mean 228 00:13:47,640 --> 00:13:51,920 Speaker 1: it's very hard to get mark down. Is that big? 229 00:13:52,520 --> 00:13:57,160 Speaker 1: So we've we Tracy started this or in the intro 230 00:13:57,280 --> 00:14:00,200 Speaker 1: we talked about all of this, the weird stuff we 231 00:14:00,320 --> 00:14:03,800 Speaker 1: keep seeing at the end of each quarter in these markets. 232 00:14:04,559 --> 00:14:07,760 Speaker 1: And I'm what is that all about? So what what's 233 00:14:07,880 --> 00:14:10,880 Speaker 1: changed such that the final several days of each quarter 234 00:14:10,960 --> 00:14:15,160 Speaker 1: become this period where suddenly stressed starts to emerge. I 235 00:14:15,160 --> 00:14:21,560 Speaker 1: think in simple terms, UM, we now have a regulatory 236 00:14:21,640 --> 00:14:27,800 Speaker 1: regime which banks are following chapter and verse. And this 237 00:14:27,960 --> 00:14:34,160 Speaker 1: regulatory regime has changed the economics of a bank's balance sheet. 238 00:14:34,360 --> 00:14:37,800 Speaker 1: And there is certain days when you have to report uh, 239 00:14:37,840 --> 00:14:41,320 Speaker 1: your leverage ratio. It used to be, you know, the 240 00:14:41,320 --> 00:14:43,840 Speaker 1: focus used to be UNRISC created assets. Now this is 241 00:14:43,880 --> 00:14:46,440 Speaker 1: just a simple leverage ratio where demotional size of your 242 00:14:46,480 --> 00:14:51,359 Speaker 1: balance sheet cannot be bigger than x. You have liquidity ratios, 243 00:14:51,560 --> 00:14:56,040 Speaker 1: term funding ratios, you have interday equidity requirements UM so 244 00:14:56,160 --> 00:14:58,400 Speaker 1: called g CP scores, which means, you know, the bigger 245 00:14:58,400 --> 00:15:01,000 Speaker 1: and the more complex you are, the more search arts 246 00:15:01,040 --> 00:15:05,520 Speaker 1: you have to carry as capital in future periods. And 247 00:15:06,120 --> 00:15:14,680 Speaker 1: you know, the the system takes these reporting dates extremely seriously. UM, 248 00:15:14,720 --> 00:15:18,280 Speaker 1: and every time these deporting rates come come by, you know, 249 00:15:18,400 --> 00:15:22,160 Speaker 1: quarter ends, year ends, year in particular, UM, banks just 250 00:15:23,120 --> 00:15:26,640 Speaker 1: shrink their balance sheets because they have to meet certain targets. 251 00:15:26,960 --> 00:15:30,880 Speaker 1: And when these balance sheets shrink, the market disappears, right 252 00:15:30,920 --> 00:15:33,000 Speaker 1: because a lot of these markets that we're talking about, 253 00:15:33,160 --> 00:15:36,920 Speaker 1: RIPO and f X pops are basically intermediated through banks 254 00:15:37,160 --> 00:15:41,560 Speaker 1: balance sheets. UM. I think academics have this tendency to 255 00:15:41,560 --> 00:15:44,560 Speaker 1: think about markets as some you know, magical cloud on 256 00:15:44,600 --> 00:15:47,480 Speaker 1: a chart that always clears. I mean, there's nothing magical 257 00:15:47,520 --> 00:15:51,320 Speaker 1: about them. It's basically people putting balance sheet on the line, 258 00:15:51,320 --> 00:15:53,200 Speaker 1: and if they take that balance sheet away, you have 259 00:15:53,280 --> 00:15:56,120 Speaker 1: a vacuum. And when you have a vacuum, great spot. 260 00:16:14,800 --> 00:16:16,880 Speaker 1: So UM, I want to go back for a second 261 00:16:16,880 --> 00:16:20,200 Speaker 1: to what we're discussing about how it's becoming more difficult 262 00:16:20,280 --> 00:16:24,880 Speaker 1: for foreign investors to buy US treasuries. Uh this basic 263 00:16:24,960 --> 00:16:27,360 Speaker 1: idea that you know, they used to be able to 264 00:16:27,360 --> 00:16:30,200 Speaker 1: buy them and then hedge them and still make one 265 00:16:30,240 --> 00:16:32,640 Speaker 1: and a half percent on something like the tenure, and 266 00:16:32,720 --> 00:16:37,120 Speaker 1: now that's not possible, partly because the FED has raised rates, 267 00:16:37,480 --> 00:16:39,920 Speaker 1: but also partly because of what's been going on in 268 00:16:39,960 --> 00:16:44,400 Speaker 1: the FX swap market. How has that changed the body 269 00:16:44,880 --> 00:16:48,760 Speaker 1: of buyers for US treasuries, How has that been different 270 00:16:49,000 --> 00:16:53,080 Speaker 1: in recent months or years? And also why should we 271 00:16:53,240 --> 00:16:57,280 Speaker 1: care about a different group buying up US treasuries as 272 00:16:57,280 --> 00:17:01,400 Speaker 1: opposed to an old group like Japan these banks. So 273 00:17:01,440 --> 00:17:03,640 Speaker 1: I'll tell you the punchline first. You should care about 274 00:17:03,640 --> 00:17:06,440 Speaker 1: this because I think all of these impacts the FEDS 275 00:17:06,880 --> 00:17:10,760 Speaker 1: ability to taper entering the balance sheet tremendously. And I 276 00:17:10,800 --> 00:17:13,840 Speaker 1: think that that concept is is he'll understood. So let's 277 00:17:14,000 --> 00:17:16,639 Speaker 1: let's start with the past and they will come to 278 00:17:16,680 --> 00:17:21,520 Speaker 1: the present. So it's been the case that foreign investors 279 00:17:21,600 --> 00:17:25,320 Speaker 1: used to be very you know, avid buyers of treasuries 280 00:17:25,760 --> 00:17:30,080 Speaker 1: at auction and again for as long as the economics 281 00:17:30,119 --> 00:17:32,159 Speaker 1: of it were there, you know, could buy treasuries and 282 00:17:32,160 --> 00:17:36,000 Speaker 1: hedge it back for a positive carry. You did it. Um. 283 00:17:36,080 --> 00:17:39,680 Speaker 1: What changed over the course of last year, and particularly 284 00:17:40,000 --> 00:17:43,920 Speaker 1: during the fourth quarter of last year, the foreign buyers 285 00:17:44,480 --> 00:17:46,600 Speaker 1: for all intents and purposes, you know, the bread and 286 00:17:46,640 --> 00:17:50,240 Speaker 1: butter hedged buyers, they disappeared. Because what happened in the 287 00:17:50,280 --> 00:17:53,960 Speaker 1: fourth quarter of last year, actually coming into the fourth quarter, 288 00:17:54,760 --> 00:18:00,720 Speaker 1: is that the yield curve um outright inverted relative to 289 00:18:01,640 --> 00:18:07,560 Speaker 1: foreign investors hedging costs. Okay, so I guess one important 290 00:18:07,600 --> 00:18:12,840 Speaker 1: observation is that people tend to obsess over the inversion um. 291 00:18:13,000 --> 00:18:15,280 Speaker 1: Then they tend to obsess about it in a way 292 00:18:15,280 --> 00:18:19,439 Speaker 1: where they measure it using three stands, and actually, like 293 00:18:19,560 --> 00:18:22,800 Speaker 1: looking at the curve shape using the three month bill 294 00:18:22,880 --> 00:18:25,680 Speaker 1: yield versus the ten year yield actually is not very 295 00:18:25,720 --> 00:18:28,800 Speaker 1: meaningful these days, because the reason why we did that 296 00:18:28,840 --> 00:18:33,040 Speaker 1: metric ten years ago, when by uh that metric had 297 00:18:33,080 --> 00:18:35,639 Speaker 1: meaning to it, was because everybody used to fund around 298 00:18:35,880 --> 00:18:38,120 Speaker 1: the three month bill yield, and everybody used to fund 299 00:18:38,160 --> 00:18:40,040 Speaker 1: around the three month bill yield because we didn't have 300 00:18:40,080 --> 00:18:45,000 Speaker 1: Basil three. Bank balance sheets were an unlimited supply, so 301 00:18:45,040 --> 00:18:48,920 Speaker 1: basically banks were arbitraging funding spreads all the way until 302 00:18:48,960 --> 00:18:51,879 Speaker 1: they roughly equaled three month billiards. And that's obviously not 303 00:18:51,960 --> 00:18:56,640 Speaker 1: the case anymore. So looking at curve slopes using three 304 00:18:56,680 --> 00:19:01,360 Speaker 1: stands makes no sense. Under Basil three, what you need 305 00:19:01,400 --> 00:19:03,960 Speaker 1: to do is actually you need to look at actual 306 00:19:04,040 --> 00:19:08,080 Speaker 1: funding costs relative to the ten year point, and that 307 00:19:08,240 --> 00:19:11,880 Speaker 1: those relative funding costs are term repo, three month lib 308 00:19:12,040 --> 00:19:15,280 Speaker 1: or three month hedging costs, and all of these rates 309 00:19:15,280 --> 00:19:17,600 Speaker 1: are going to be you can translate, as you know, 310 00:19:17,680 --> 00:19:22,399 Speaker 1: three month bills plus twenty three month bills plus forty 311 00:19:22,440 --> 00:19:26,479 Speaker 1: three month bills plus okay, and so those are your 312 00:19:26,480 --> 00:19:30,520 Speaker 1: actual funding costom when you look at UM the level 313 00:19:30,560 --> 00:19:33,400 Speaker 1: of these actual funding rates relative to the tenure, relative 314 00:19:33,440 --> 00:19:38,560 Speaker 1: to all of them. The curve has inverted last October, 315 00:19:38,640 --> 00:19:41,040 Speaker 1: the first week of October UM. And the reason for 316 00:19:41,119 --> 00:19:44,280 Speaker 1: that was obviously you had the year and turn was 317 00:19:44,320 --> 00:19:47,600 Speaker 1: getting priced into the FX pop markets UM, so you 318 00:19:47,640 --> 00:19:51,440 Speaker 1: had a big pop in hedging costs. Library was going 319 00:19:51,480 --> 00:19:55,360 Speaker 1: through its typical year and UH widening, which has been 320 00:19:55,640 --> 00:19:59,160 Speaker 1: a mainstay of of of the post Bassal three regime. 321 00:19:59,200 --> 00:20:02,439 Speaker 1: And you know, collateral supply and treasury issuance was heavy 322 00:20:02,760 --> 00:20:08,280 Speaker 1: and that was pressuring GC rates. And so you know, interestingly, 323 00:20:08,680 --> 00:20:11,359 Speaker 1: you know, even though the outright inversion only happened one 324 00:20:11,440 --> 00:20:14,760 Speaker 1: or two weeks ago, relative to the rates that matter, 325 00:20:15,359 --> 00:20:19,280 Speaker 1: we've been living in an inverted curve environment since last October, 326 00:20:20,040 --> 00:20:23,040 Speaker 1: which I cannot find it important to highlight because sometimes 327 00:20:23,040 --> 00:20:26,040 Speaker 1: you can still read fat speeches that say, while I'm 328 00:20:26,080 --> 00:20:29,680 Speaker 1: not worried about the inversion just yet, because it only 329 00:20:29,760 --> 00:20:33,359 Speaker 1: lasted two weeks, and I want to see deeper than 330 00:20:33,440 --> 00:20:36,080 Speaker 1: what we can actually see in three stands. Well, actually 331 00:20:36,160 --> 00:20:39,400 Speaker 1: it didn't happen only two weeks ago, but since last October, 332 00:20:40,000 --> 00:20:42,040 Speaker 1: and depending on what funding rids you look at, it's 333 00:20:42,080 --> 00:20:46,200 Speaker 1: been as deep as thirty or forty basis points. So 334 00:20:46,200 --> 00:20:49,040 Speaker 1: so these things, these things are changing as we speak. 335 00:20:50,000 --> 00:20:53,399 Speaker 1: So we are living through this inversion. And importantly, you know, 336 00:20:53,440 --> 00:20:56,879 Speaker 1: to get back to your question, Tracy, when this inversion happens, 337 00:20:56,920 --> 00:21:01,320 Speaker 1: you basically knock away a few by buyers potential buyers 338 00:21:01,440 --> 00:21:04,720 Speaker 1: of treasuries. So if the foreign hatched buyer cannot buy 339 00:21:04,720 --> 00:21:09,160 Speaker 1: this buy treasuries at auctions, then that's one buyer base 340 00:21:09,280 --> 00:21:12,600 Speaker 1: that goes away. If you're a bank and you cannot 341 00:21:12,680 --> 00:21:15,159 Speaker 1: fund that the three month point in the CD and 342 00:21:15,200 --> 00:21:18,000 Speaker 1: CP markets and buy treasuries at a positive carry, you're 343 00:21:18,040 --> 00:21:20,320 Speaker 1: not that buyer base away. So you just basically start 344 00:21:20,359 --> 00:21:25,600 Speaker 1: to eliminate all the buyers that have been coming to 345 00:21:25,800 --> 00:21:29,040 Speaker 1: the treasury market. But then there's a very special buyer base, 346 00:21:29,200 --> 00:21:33,280 Speaker 1: which is the dealers who by law have to buy 347 00:21:33,320 --> 00:21:36,560 Speaker 1: if nobody else buys um and that's what you do 348 00:21:36,640 --> 00:21:39,240 Speaker 1: as a primary dealer. That's by auctions don't fail in 349 00:21:39,320 --> 00:21:43,040 Speaker 1: the US at least and if nobody else buys, but 350 00:21:43,080 --> 00:21:45,679 Speaker 1: the dealers have to. You know, the dealers don't have 351 00:21:45,720 --> 00:21:49,439 Speaker 1: the money. The dealers are funded entities. And if you 352 00:21:49,520 --> 00:21:52,280 Speaker 1: end up in a situation where you have to take 353 00:21:52,359 --> 00:21:57,560 Speaker 1: down a large chunk of treasuries unexpectedly because the auctions 354 00:21:57,560 --> 00:22:00,840 Speaker 1: go bad, then you basically need a lot of repo 355 00:22:01,040 --> 00:22:05,040 Speaker 1: funding to take those treasuries downe and finance them. And 356 00:22:05,040 --> 00:22:07,679 Speaker 1: that's precisely what happened during the fourth quarter of last year. 357 00:22:07,760 --> 00:22:10,680 Speaker 1: You had this shock where you know, hedging costs and 358 00:22:10,720 --> 00:22:13,560 Speaker 1: all these other funding rates got to on economic levels. 359 00:22:13,600 --> 00:22:16,840 Speaker 1: The dealers had no choice but to take down the treasuries. 360 00:22:17,119 --> 00:22:18,639 Speaker 1: They had no choice but to fund it in the 361 00:22:18,720 --> 00:22:21,959 Speaker 1: report market. And basically the way that transpired was they 362 00:22:22,040 --> 00:22:26,320 Speaker 1: leaned extremely heavily to a handful of large banks, and 363 00:22:26,400 --> 00:22:30,080 Speaker 1: into those large banks hqu a portfolio, and they completely 364 00:22:30,119 --> 00:22:34,000 Speaker 1: stressed out the report market because of that. So I 365 00:22:34,040 --> 00:22:36,320 Speaker 1: guess before we get further into the details, I guess 366 00:22:36,480 --> 00:22:38,879 Speaker 1: you know what I just told you about how this 367 00:22:39,000 --> 00:22:42,479 Speaker 1: impact is the FEDS a bit of the taper. The 368 00:22:42,480 --> 00:22:45,080 Speaker 1: The important thing here to appreciate is that once you 369 00:22:45,080 --> 00:22:47,520 Speaker 1: get into overnight markets where these dealers tend to fund 370 00:22:47,520 --> 00:22:51,600 Speaker 1: their inventories if you lean very heavily onto the onto 371 00:22:51,640 --> 00:22:54,640 Speaker 1: the overnight repo market and you stress out rates there. 372 00:22:55,240 --> 00:22:58,160 Speaker 1: Basically the way that manifests itself is that report rates 373 00:22:58,200 --> 00:23:01,520 Speaker 1: are going to trade our outside the fat's target range 374 00:23:01,640 --> 00:23:06,080 Speaker 1: for the overnight funds rate. UH and you know, as 375 00:23:06,080 --> 00:23:09,120 Speaker 1: they like to call it, the constellation of short term 376 00:23:09,160 --> 00:23:13,399 Speaker 1: interest rates. And you know, as a central bank, UH, 377 00:23:13,680 --> 00:23:16,800 Speaker 1: the FED cares deeply about where overnight rates print relative 378 00:23:16,840 --> 00:23:19,080 Speaker 1: to the band because that's one of the most important 379 00:23:19,080 --> 00:23:20,920 Speaker 1: mandates you have as a central bank to make sure 380 00:23:20,960 --> 00:23:24,919 Speaker 1: that that overnight rates print print within the target. And 381 00:23:24,960 --> 00:23:29,320 Speaker 1: once you have difficulty in controlling that, then you you know, 382 00:23:29,640 --> 00:23:31,520 Speaker 1: open up a whole new kind of worms. And that's 383 00:23:31,520 --> 00:23:33,879 Speaker 1: what basically forces you to rethink how much you can 384 00:23:33,920 --> 00:23:38,080 Speaker 1: actually taper, because whether report rates print within the band 385 00:23:38,200 --> 00:23:41,080 Speaker 1: or outside the band ultimately come down to how many 386 00:23:41,119 --> 00:23:44,119 Speaker 1: reserves there are in the system. Yeah, no, this is 387 00:23:44,320 --> 00:23:47,520 Speaker 1: this is the part I think I could use and 388 00:23:47,880 --> 00:23:51,480 Speaker 1: maybe some listeners could use a lot of clarification about, 389 00:23:51,520 --> 00:23:55,639 Speaker 1: because obviously the fact that the FED is going to 390 00:23:55,840 --> 00:23:58,480 Speaker 1: halt its wine down of the balance sheet this year 391 00:23:58,680 --> 00:24:01,760 Speaker 1: is a very a lot of people talking about it 392 00:24:01,800 --> 00:24:05,560 Speaker 1: without much understanding, and people like, oh, they're they they 393 00:24:05,560 --> 00:24:09,280 Speaker 1: were stopping. They think maybe there's some I mean, it 394 00:24:09,320 --> 00:24:11,000 Speaker 1: feels like the debate is like, oh, is this some 395 00:24:11,080 --> 00:24:14,040 Speaker 1: economic thing or is this some technical thing? And it 396 00:24:14,080 --> 00:24:16,720 Speaker 1: feels like a lot of people think of some economic 397 00:24:16,760 --> 00:24:18,920 Speaker 1: thing where something is telling the Fed, oh, you can't 398 00:24:18,960 --> 00:24:21,640 Speaker 1: keep winding it down, and the Fed is trying to say, no, 399 00:24:21,760 --> 00:24:23,879 Speaker 1: this is just sort of we wanted to be boring. 400 00:24:24,000 --> 00:24:27,040 Speaker 1: This is more of just about the sort of technical stuff. 401 00:24:27,080 --> 00:24:30,760 Speaker 1: So explain this further. What is going on in the 402 00:24:30,800 --> 00:24:34,680 Speaker 1: market that requires them to, uh, you know, the demand 403 00:24:34,760 --> 00:24:37,760 Speaker 1: for federal for reserves that they can't go below a 404 00:24:37,760 --> 00:24:42,879 Speaker 1: certain level. Okay, So I know that question wasn't particularly articulate. No, no, 405 00:24:42,960 --> 00:24:45,959 Speaker 1: it's it was. But I think it was a broad question, right, 406 00:24:45,960 --> 00:24:47,400 Speaker 1: So I said, you know, how do you go from 407 00:24:48,320 --> 00:24:50,679 Speaker 1: stresses in the report market to ending taper? So I 408 00:24:50,680 --> 00:24:52,560 Speaker 1: think it was a little bit more complicated than there 409 00:24:52,600 --> 00:24:56,080 Speaker 1: were actual reasons for it, and then there were technical 410 00:24:56,119 --> 00:24:59,760 Speaker 1: reasons for it. I think the macro is that, you know, 411 00:25:00,040 --> 00:25:02,760 Speaker 1: the period we're talking about the end of last year 412 00:25:02,920 --> 00:25:07,199 Speaker 1: coincided with a global ip cycle. Slow down. You know, 413 00:25:07,200 --> 00:25:10,560 Speaker 1: our economics team is quite prolific about you know, tracking 414 00:25:10,640 --> 00:25:14,119 Speaker 1: all that stuff and and so. Um. Just you know, 415 00:25:14,160 --> 00:25:16,640 Speaker 1: give you a nutshell version of this. You know, IP 416 00:25:16,800 --> 00:25:22,280 Speaker 1: cycles are regular, and the Central Bank tends to overreact 417 00:25:22,359 --> 00:25:25,920 Speaker 1: to them. Markets tends to be driven by them. Um. 418 00:25:26,000 --> 00:25:28,760 Speaker 1: So every time you have these episodes where the IP 419 00:25:28,880 --> 00:25:32,919 Speaker 1: cycle is troughing and things get dark, you know, people 420 00:25:33,040 --> 00:25:36,199 Speaker 1: blues confidence about you know, the genevity of the cycle 421 00:25:36,280 --> 00:25:39,920 Speaker 1: and uh and whatnot. So so that was one one 422 00:25:39,960 --> 00:25:42,879 Speaker 1: part of it. The other more technical part of it 423 00:25:42,880 --> 00:25:46,160 Speaker 1: would be that, you know, the fact that we had 424 00:25:46,200 --> 00:25:51,360 Speaker 1: this sell off and risk assets during the fourth quarter. Okay, um. 425 00:25:51,480 --> 00:25:54,040 Speaker 1: Some of it again has to do with the IP cycle, 426 00:25:54,600 --> 00:25:56,119 Speaker 1: but some of it also has to do with the 427 00:25:56,119 --> 00:25:59,359 Speaker 1: fact that if you think about a dealer's balance yount 428 00:25:59,359 --> 00:26:03,760 Speaker 1: given house Air's balance sheets are post basal tree. If 429 00:26:03,800 --> 00:26:06,600 Speaker 1: you are a dealer that by law has to now 430 00:26:06,640 --> 00:26:09,600 Speaker 1: absorb two hundred billion of treasuries during the fourth quarter 431 00:26:09,840 --> 00:26:13,240 Speaker 1: because there's nobody else's buying it, you have to make 432 00:26:13,359 --> 00:26:18,600 Speaker 1: room on your balance sheet to absorb all that paper. Okay, 433 00:26:18,720 --> 00:26:22,320 Speaker 1: So if your balance sheet is limited and you have 434 00:26:22,400 --> 00:26:25,240 Speaker 1: no choice but to buy this stuff, you have to 435 00:26:25,280 --> 00:26:27,800 Speaker 1: make room by selling other stuff. And when you look 436 00:26:27,840 --> 00:26:32,160 Speaker 1: at dealer inventories by component during the fourth quarter, as 437 00:26:32,200 --> 00:26:35,320 Speaker 1: they were absorbing the two hundred billion dollars worth of treasuries, 438 00:26:36,080 --> 00:26:39,760 Speaker 1: they were trimming their inventories in virtually all other asset classes. 439 00:26:39,800 --> 00:26:42,760 Speaker 1: So whether you look at I G or high yield 440 00:26:42,920 --> 00:26:48,359 Speaker 1: or UM, you know, any any imaginable form of risk assets, equities, 441 00:26:49,080 --> 00:26:51,359 Speaker 1: if you think about the amount of balance sheet that 442 00:26:51,400 --> 00:26:53,880 Speaker 1: you want to deploy to I don't know, equity futures 443 00:26:53,920 --> 00:26:57,119 Speaker 1: and funding you know, hedge funds, long positions in in 444 00:26:57,160 --> 00:26:59,280 Speaker 1: the equity market, you have to tream all that stuff. 445 00:26:59,680 --> 00:27:02,240 Speaker 1: When you trim it, it doesn't do anything good to 446 00:27:02,280 --> 00:27:07,040 Speaker 1: equity valuations or credit spreads, right, So you know, George 447 00:27:07,040 --> 00:27:09,840 Speaker 1: Source would say that things are reflexive. So sure, you 448 00:27:09,880 --> 00:27:14,439 Speaker 1: have an IP cycle making people feel dead about the world, 449 00:27:14,440 --> 00:27:16,760 Speaker 1: and then you actually have these technical adjustments that have 450 00:27:16,880 --> 00:27:20,600 Speaker 1: to go through dealer balance sheets, which it's probably informed 451 00:27:20,600 --> 00:27:23,159 Speaker 1: by the I P cycle, but it's also making the 452 00:27:23,200 --> 00:27:26,800 Speaker 1: IP cycle's perception worse because you risk assets are doing 453 00:27:27,640 --> 00:27:32,600 Speaker 1: ugly things. So you know these things are there. They 454 00:27:32,600 --> 00:27:35,400 Speaker 1: were basically happening all at the same time to get 455 00:27:35,440 --> 00:27:41,320 Speaker 1: into the super technical aspects of this. Why do reserves 456 00:27:41,320 --> 00:27:44,320 Speaker 1: and balance sheet taper matter? Well, they they matter because 457 00:27:44,720 --> 00:27:47,600 Speaker 1: you know, post puzzle three, I think an important feature 458 00:27:47,640 --> 00:27:52,960 Speaker 1: of the system is that every possible trade or flow 459 00:27:53,119 --> 00:27:56,560 Speaker 1: inter bank or dealer to bank or non bank to 460 00:27:56,640 --> 00:28:02,240 Speaker 1: bank settles through the movement of reserves. Okay, And so 461 00:28:02,320 --> 00:28:05,520 Speaker 1: that's point number one. Point number two. It used to 462 00:28:05,560 --> 00:28:11,480 Speaker 1: be the case that before Basil three, non banks leaned 463 00:28:11,520 --> 00:28:15,480 Speaker 1: heavily on clearing banks for intraday credit, and then the 464 00:28:15,520 --> 00:28:17,720 Speaker 1: clearing banks and the large banks leaned on the ft 465 00:28:17,840 --> 00:28:22,040 Speaker 1: for interday credit. Uh, And that intraday credit provision doesn't 466 00:28:22,080 --> 00:28:27,200 Speaker 1: really happen anymore simply because there is stigma associated with 467 00:28:27,480 --> 00:28:30,680 Speaker 1: tapping the FED for credit even on an intraday basis, 468 00:28:31,440 --> 00:28:35,399 Speaker 1: and the price of interey credit provision between non banks 469 00:28:35,440 --> 00:28:38,840 Speaker 1: and and clearing banks has gotten a lot more expensive. 470 00:28:39,560 --> 00:28:42,040 Speaker 1: So basically, the system is trying to get trades and 471 00:28:42,080 --> 00:28:44,560 Speaker 1: flows done with the amount of reserves that are in 472 00:28:44,600 --> 00:28:50,080 Speaker 1: the system. Taper, for all intents and purposes, is impacting 473 00:28:50,640 --> 00:28:54,120 Speaker 1: that quantity of reserves, right because every time bonds come 474 00:28:54,160 --> 00:28:56,720 Speaker 1: into the system and the FED takes cash out, you 475 00:28:56,800 --> 00:28:58,800 Speaker 1: just reduce the amount of reserves in the system. So 476 00:28:58,840 --> 00:29:02,160 Speaker 1: the s degree if you will, that settles all the 477 00:29:02,200 --> 00:29:07,640 Speaker 1: flows is getting, you know, scarcer and scarcer. And you know, 478 00:29:07,960 --> 00:29:12,280 Speaker 1: days like December thirty one, when report rates popped four 479 00:29:12,640 --> 00:29:18,600 Speaker 1: basis points outside the target band happened precisely because when 480 00:29:18,640 --> 00:29:22,200 Speaker 1: it comes to clearing some of these trades, uh, there's 481 00:29:22,240 --> 00:29:24,240 Speaker 1: just not enough tokens in the system to get this 482 00:29:24,280 --> 00:29:27,920 Speaker 1: stuff done. And you know, December thirty one and the 483 00:29:27,960 --> 00:29:31,360 Speaker 1: fourth quarter of last year was a particularly bad kind 484 00:29:31,360 --> 00:29:34,440 Speaker 1: of quarter end because not only was it a year end, 485 00:29:35,200 --> 00:29:38,600 Speaker 1: but also you had this outright inversion that the system 486 00:29:38,640 --> 00:29:41,280 Speaker 1: had to deal with, and the dealers had to fund 487 00:29:41,840 --> 00:29:45,240 Speaker 1: the inventories they got backed up with. December thirty one 488 00:29:45,440 --> 00:29:48,840 Speaker 1: was also a settlement date, so everything that could possibly 489 00:29:48,840 --> 00:29:52,640 Speaker 1: go wrong went bad. But you know, funding a bank 490 00:29:52,720 --> 00:29:56,000 Speaker 1: and financial markets are not a science. I mean, bad 491 00:29:56,080 --> 00:29:59,000 Speaker 1: days happen. And the important thing that we've learned on 492 00:29:59,040 --> 00:30:02,080 Speaker 1: December thirty one is that really there's one or two 493 00:30:02,200 --> 00:30:06,200 Speaker 1: large banks that have the amount of reserves ready to 494 00:30:06,440 --> 00:30:09,920 Speaker 1: help the report markets clear. And then those one or 495 00:30:09,920 --> 00:30:14,600 Speaker 1: two banks reached the amount of reach the limit of 496 00:30:14,640 --> 00:30:18,280 Speaker 1: how much reserves they can lend into the market, bad 497 00:30:18,320 --> 00:30:22,440 Speaker 1: things happen, and I think it's just not good policy 498 00:30:22,480 --> 00:30:25,080 Speaker 1: and not good for financial stability when you have one 499 00:30:25,160 --> 00:30:27,600 Speaker 1: or to private institutions like that and you have no 500 00:30:27,760 --> 00:30:33,000 Speaker 1: formal backstop provided by the FAT for example, that would 501 00:30:33,680 --> 00:30:36,440 Speaker 1: you know, preclude the system from having to deal with 502 00:30:36,560 --> 00:30:39,680 Speaker 1: days like that. Again, So here's something I always wonder. 503 00:30:39,840 --> 00:30:44,360 Speaker 1: Do you think that in the course of creating, you know, 504 00:30:44,480 --> 00:30:49,720 Speaker 1: post financial crisis regulation like new basil requirements, like the 505 00:30:49,960 --> 00:30:54,200 Speaker 1: High Quality Um Liquid Assets Rule h q l A, 506 00:30:54,440 --> 00:30:56,280 Speaker 1: this this notion that banks had to hold a bunch 507 00:30:56,320 --> 00:30:59,560 Speaker 1: of you know, liquid and top rated stuff, and in 508 00:30:59,600 --> 00:31:05,640 Speaker 1: the core formulating unconventional monetary policy. Do you think the 509 00:31:05,760 --> 00:31:09,880 Speaker 1: Fed ever thought what it would look like if those 510 00:31:09,920 --> 00:31:12,720 Speaker 1: two things sort of collided together. Do you think they 511 00:31:12,720 --> 00:31:16,040 Speaker 1: were thinking that much about the interplay between the new 512 00:31:16,080 --> 00:31:20,440 Speaker 1: regulations and what was happening to their balance sheet. I'm 513 00:31:20,440 --> 00:31:22,719 Speaker 1: sure they were thinking about it. I think no one 514 00:31:22,840 --> 00:31:26,720 Speaker 1: really knew what this what this tipping point was, you know, 515 00:31:26,760 --> 00:31:29,280 Speaker 1: so everybody knew that basil she was out there. Everybody 516 00:31:29,320 --> 00:31:31,400 Speaker 1: knew that banks have to hold h q l A. 517 00:31:32,120 --> 00:31:36,719 Speaker 1: What does that standford high quality liquid assets reserves and treasuries. 518 00:31:37,360 --> 00:31:41,680 Speaker 1: I think where where people get a bit fuzzy was that, 519 00:31:45,880 --> 00:31:48,800 Speaker 1: you know, the conventional wisdom was that, okay, well there's 520 00:31:49,240 --> 00:31:51,520 Speaker 1: h l A and there's level one H and level 521 00:31:51,520 --> 00:31:54,520 Speaker 1: two H. So when we taper, all we're really doing 522 00:31:54,600 --> 00:31:57,160 Speaker 1: is we are taking away one type of level one 523 00:31:57,280 --> 00:32:00,000 Speaker 1: h l A, which is reserves, and we are replaced 524 00:32:00,000 --> 00:32:03,240 Speaker 1: seeing it with another which is treasuries, which is fine, 525 00:32:03,960 --> 00:32:07,920 Speaker 1: but from A. And this is actually very interesting, right 526 00:32:07,960 --> 00:32:13,320 Speaker 1: because all these lcrs, the liquity coverage ratios that require 527 00:32:13,360 --> 00:32:17,520 Speaker 1: the banks to hold the liquid assets are based on 528 00:32:17,720 --> 00:32:21,720 Speaker 1: end of day balance sheet snapshots. Okay. So that means 529 00:32:21,760 --> 00:32:24,400 Speaker 1: that if your liabilities are this and x amount of 530 00:32:24,440 --> 00:32:28,840 Speaker 1: these mature within dirty days, you need to hold um 531 00:32:29,120 --> 00:32:32,440 Speaker 1: level one h q A against them to back them 532 00:32:32,480 --> 00:32:38,280 Speaker 1: up and to comply with your liquidity coverage ratio. But um, 533 00:32:38,520 --> 00:32:41,760 Speaker 1: you know end of DAI liquiity snapshots that require you 534 00:32:41,800 --> 00:32:46,120 Speaker 1: to hold liquid assets that will cover your outflows over 535 00:32:46,120 --> 00:32:49,840 Speaker 1: the next dirty days. None of that requires that your 536 00:32:49,920 --> 00:32:53,440 Speaker 1: asset has to be able to provide intra day liquidity. Okay. 537 00:32:53,440 --> 00:32:56,160 Speaker 1: And and this is where this is where things get complicated, 538 00:32:56,200 --> 00:33:01,640 Speaker 1: because reserves are basically my for banks that banks keep 539 00:33:01,640 --> 00:33:04,960 Speaker 1: at the FED. And every time flows happened between banks 540 00:33:05,040 --> 00:33:10,240 Speaker 1: during the day, literally reserves go from one bank's account 541 00:33:10,280 --> 00:33:12,520 Speaker 1: at the FED to another bank's account at the FED 542 00:33:13,360 --> 00:33:16,560 Speaker 1: a million times a day. And the only instrument that 543 00:33:16,600 --> 00:33:18,480 Speaker 1: you can take that that you can use to take 544 00:33:18,480 --> 00:33:21,680 Speaker 1: care of these intra reserve account flows are reserves. You know, 545 00:33:21,760 --> 00:33:25,080 Speaker 1: treasuries you can sell today, but you only get liquidity tomorrow. 546 00:33:25,840 --> 00:33:27,880 Speaker 1: And if you land in the report market today, you 547 00:33:27,920 --> 00:33:31,520 Speaker 1: will only get your money back the next day. Right, So, 548 00:33:31,520 --> 00:33:35,040 Speaker 1: so I think where things got complicated and where things 549 00:33:35,040 --> 00:33:38,520 Speaker 1: where the market? And and I guess um the Central 550 00:33:38,520 --> 00:33:42,560 Speaker 1: Bank wasn't thinking too clearly about is that these intra 551 00:33:42,680 --> 00:33:47,000 Speaker 1: day flows matter. And for some of these flows you 552 00:33:47,040 --> 00:33:50,960 Speaker 1: can only use reserves. And when you cut too deep 553 00:33:51,000 --> 00:33:54,880 Speaker 1: into the reserve needs of the system for inter day purposes, 554 00:33:55,040 --> 00:33:58,920 Speaker 1: you have you have hiccups like December thirty one. December 555 00:33:58,960 --> 00:34:02,400 Speaker 1: thirty one is a day where interday liquidity needs are 556 00:34:02,520 --> 00:34:06,440 Speaker 1: especially high. But again, you know, bad days can happen anytime, 557 00:34:06,480 --> 00:34:09,200 Speaker 1: and and and the December thirty first episode just tells 558 00:34:09,239 --> 00:34:11,160 Speaker 1: us that, you know, we are quite close. We are 559 00:34:11,160 --> 00:34:15,919 Speaker 1: basically two hundred billion away from from having these bad 560 00:34:16,000 --> 00:34:21,120 Speaker 1: days potentially be more regular. So in theory, reserves and 561 00:34:21,360 --> 00:34:27,600 Speaker 1: treasuries should they should be essentially the same quality asset 562 00:34:28,280 --> 00:34:31,640 Speaker 1: um on the bank's balance sheet, but because of their 563 00:34:31,719 --> 00:34:37,560 Speaker 1: different daily liquidity or intraday liquidity characteristics, they don't exactly 564 00:34:37,600 --> 00:34:40,960 Speaker 1: serve the same purpose. So what is there something that 565 00:34:41,000 --> 00:34:44,840 Speaker 1: should be done from a regulatory basis to avoid days 566 00:34:45,000 --> 00:34:48,600 Speaker 1: like December thirty one or other periods in which it's 567 00:34:48,719 --> 00:34:52,840 Speaker 1: essentially the stress imposed by the regulations itself that caused 568 00:34:52,880 --> 00:34:55,760 Speaker 1: the tension. Well, I think it's it's a philosophical question. 569 00:34:55,840 --> 00:34:59,759 Speaker 1: I think I think the superstructure of of the regulatory 570 00:35:00,000 --> 00:35:04,960 Speaker 1: a work is correct. I think, um, you know, the 571 00:35:05,040 --> 00:35:08,680 Speaker 1: rules are clear, banks are living with those rules. I 572 00:35:08,680 --> 00:35:12,680 Speaker 1: would say that what's needed is not a tinkering with 573 00:35:13,200 --> 00:35:17,359 Speaker 1: the architecture of bottle tree or the interpretation of it. 574 00:35:17,880 --> 00:35:20,920 Speaker 1: But what's needed is is a is a simple plumbing 575 00:35:20,960 --> 00:35:25,080 Speaker 1: fix where if you have some days where reserves get 576 00:35:25,120 --> 00:35:28,680 Speaker 1: scarce for whatever reason, you should have an entity in 577 00:35:28,719 --> 00:35:31,239 Speaker 1: the system that is going to put those reserves into 578 00:35:31,239 --> 00:35:36,160 Speaker 1: the system on a temporary basis to control prices staying 579 00:35:36,239 --> 00:35:40,480 Speaker 1: within the target band. Um. So I think that's the 580 00:35:40,960 --> 00:35:43,600 Speaker 1: that's the path of least resistance, and that's that's where 581 00:35:43,600 --> 00:35:47,799 Speaker 1: the should that's where the solution should be coming from. 582 00:35:47,840 --> 00:35:50,840 Speaker 1: So basically, I think, you know, it's it's either providing 583 00:35:50,840 --> 00:35:56,000 Speaker 1: more balance sheet elasticity for the private system through tinkering 584 00:35:56,040 --> 00:35:59,880 Speaker 1: with regulations, or having a central bank that's willing to 585 00:36:00,120 --> 00:36:02,760 Speaker 1: ride that balance at elasticity because they can and because 586 00:36:02,760 --> 00:36:06,560 Speaker 1: that's their job and roll. Basically, so I think the 587 00:36:06,600 --> 00:36:10,839 Speaker 1: path of these resistance politically and technically and from all 588 00:36:10,880 --> 00:36:14,000 Speaker 1: sorts of angles is is a central bank doing what 589 00:36:14,120 --> 00:36:17,239 Speaker 1: a central bank golf to do. All right, Sultan, I 590 00:36:17,239 --> 00:36:19,120 Speaker 1: think we're going to have to leave it there. Sultan 591 00:36:19,200 --> 00:36:22,480 Speaker 1: Posar from Credit Swiss, thank you so much. That was fantastic. 592 00:36:22,560 --> 00:36:37,720 Speaker 1: Thank you very much. Thank you for having me. Joe. 593 00:36:38,040 --> 00:36:41,719 Speaker 1: I've really enjoyed that conversation, if only because it really 594 00:36:41,760 --> 00:36:45,240 Speaker 1: puts the yield curve inversion from the past few weeks 595 00:36:45,440 --> 00:36:48,600 Speaker 1: in perspective, like everyone is going nuts because the old 596 00:36:48,600 --> 00:36:51,719 Speaker 1: curve has inverted, and Sultan comes on and he's like, no, no, no, 597 00:36:51,800 --> 00:36:57,000 Speaker 1: it's been inverted since October. Yeah. I really like that conversation. Actually, 598 00:36:57,040 --> 00:37:00,480 Speaker 1: it was exactly what I needed. I just think that 599 00:37:00,640 --> 00:37:02,080 Speaker 1: you know, as I said in my intro, I really 600 00:37:02,080 --> 00:37:04,600 Speaker 1: didn't know very much about this topic, and I think 601 00:37:04,640 --> 00:37:07,480 Speaker 1: my sort of incoherent questions sort of proved that. But 602 00:37:07,520 --> 00:37:12,400 Speaker 1: it was exactly the sort of very clear conversation that 603 00:37:12,440 --> 00:37:14,279 Speaker 1: I needed. And now I'm going to like read much 604 00:37:14,320 --> 00:37:17,480 Speaker 1: more note and actually have some sort of understanding of 605 00:37:17,840 --> 00:37:19,960 Speaker 1: what this is all about. Yeah, I think it's a 606 00:37:19,960 --> 00:37:23,080 Speaker 1: really good reminder that often the way a lot of 607 00:37:23,080 --> 00:37:27,319 Speaker 1: people talk about the market isn't necessarily reflective of the 608 00:37:27,360 --> 00:37:30,920 Speaker 1: way that market actually functions. And I mean there's a 609 00:37:30,920 --> 00:37:33,280 Speaker 1: reason we do it, because if we started talking about 610 00:37:33,760 --> 00:37:37,040 Speaker 1: demand for U. S. Treasuries in FX hedge terms and 611 00:37:37,080 --> 00:37:39,560 Speaker 1: things like that, I think, you know, we would never 612 00:37:39,640 --> 00:37:43,720 Speaker 1: get a full sentence out. But it's actually really really 613 00:37:43,760 --> 00:37:47,520 Speaker 1: important to consider things like currency hedging costs when we're 614 00:37:47,560 --> 00:37:50,760 Speaker 1: talking about demand for U. S. Treasuries, And so rarely 615 00:37:51,120 --> 00:37:52,960 Speaker 1: do we hear the thing I think that we do, 616 00:37:53,160 --> 00:37:55,520 Speaker 1: or maybe I'm just projecting and I do it's just 617 00:37:55,640 --> 00:38:00,520 Speaker 1: sort of abstract away um various technical factor that could 618 00:38:00,520 --> 00:38:03,840 Speaker 1: be impacting the market. So even something like that last point, 619 00:38:04,239 --> 00:38:07,680 Speaker 1: where in my mind I tend to think of reserves 620 00:38:07,719 --> 00:38:11,880 Speaker 1: held at the FED and treasuries as being equal quality assets, 621 00:38:12,160 --> 00:38:15,239 Speaker 1: the fact that under the current regulatory system, because of 622 00:38:15,280 --> 00:38:19,040 Speaker 1: their different liquidity characteristics, they are different and there are 623 00:38:19,080 --> 00:38:22,759 Speaker 1: times when they are not substitutes for one another that 624 00:38:22,760 --> 00:38:25,600 Speaker 1: that is going to have an impact on things that 625 00:38:25,600 --> 00:38:28,359 Speaker 1: show up in the market. So, in other words, all 626 00:38:28,440 --> 00:38:32,160 Speaker 1: these things, like you know, the basil requirements, like the 627 00:38:32,200 --> 00:38:34,520 Speaker 1: sizes of the balance sheet, like they're real and we 628 00:38:34,600 --> 00:38:38,920 Speaker 1: can't just sort of um abstract them away, and I 629 00:38:39,160 --> 00:38:42,319 Speaker 1: sort of think that they don't really matter. Yeah, absolutely, 630 00:38:42,320 --> 00:38:44,759 Speaker 1: But if anything, you know, the next time you hear 631 00:38:44,840 --> 00:38:48,319 Speaker 1: that primary dealer inventories of U S. Treasuries are at 632 00:38:48,320 --> 00:38:52,040 Speaker 1: an all time high, you shouldn't necessarily see that as 633 00:38:52,080 --> 00:38:54,040 Speaker 1: the sort of end of the world, but as a 634 00:38:54,080 --> 00:38:56,680 Speaker 1: function of some of the big changes in money marks 635 00:38:56,880 --> 00:39:00,319 Speaker 1: markets that we have been discussing. Should we eve it there? 636 00:39:00,360 --> 00:39:02,120 Speaker 1: We've got there, and you know, like I still have 637 00:39:02,120 --> 00:39:04,239 Speaker 1: a lot to learn, but I do feel after this 638 00:39:04,280 --> 00:39:08,239 Speaker 1: conversation maybe I'm getting a little bit more understanding. We'll 639 00:39:08,239 --> 00:39:11,520 Speaker 1: have Sultan on again. I'll talk more in the meantime. 640 00:39:11,640 --> 00:39:14,280 Speaker 1: This has been another edition of the All Thoughts podcast. 641 00:39:14,320 --> 00:39:16,680 Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at 642 00:39:16,719 --> 00:39:19,520 Speaker 1: Tracy Alloway and I'm Joe Wisintho. You could follow me 643 00:39:19,640 --> 00:39:22,440 Speaker 1: on Twitter at the Stalwart, and you should follow our 644 00:39:22,440 --> 00:39:25,719 Speaker 1: producer on Twitter. He's told for Foreheads. His handle is 645 00:39:25,840 --> 00:39:29,320 Speaker 1: at foreheads T, as well as the Bloomberg head of podcast, 646 00:39:29,400 --> 00:39:33,360 Speaker 1: Francesca Levi at Francesca Today. Thanks for listening.