WEBVTT - Why Foreign Investors Cooled On U.S. Debt 0:00:10.920 --> 0:00:14.240 Hello, and welcome to another episode of the Odd Thoughts Podcast. 0:00:14.280 --> 0:00:17.880 I'm Chracy Allowin and I'm Joe. Joe. You know it 0:00:17.960 --> 0:00:23.640 just happened. It's a very very open ended question, so 0:00:24.760 --> 0:00:30.400 I need to tell me what happened. Alright, So let's 0:00:30.440 --> 0:00:33.800 see a couple of weeks ago. It not only was 0:00:33.920 --> 0:00:38.159 the end of the first quarter, uh it was the 0:00:38.280 --> 0:00:41.760 end of March. It was also the end of the 0:00:41.880 --> 0:00:46.800 fiscal year for a lot of big Asia investors, specifically 0:00:47.000 --> 0:00:49.479 Japanese banks. I know that is the highlight of your 0:00:49.520 --> 0:00:52.640 calendar every year. Did you celebrate? I like, do people 0:00:52.760 --> 0:00:56.160 out there do a fiscal New Year's celebration? I mean, 0:00:56.200 --> 0:00:58.960 I know there's a lot of finance out there in 0:00:59.080 --> 0:01:01.240 Hong Kong, and so is that a thing out there 0:01:01.320 --> 0:01:05.039 or is that just it's not the same? Uh I. 0:01:05.040 --> 0:01:09.039 I confess that I didn't notice anyone um celebrating more 0:01:09.080 --> 0:01:11.680 than usual. I did write a high ku on Twitter, though, 0:01:12.400 --> 0:01:16.240 and my high ku, my high ku was about stress 0:01:16.280 --> 0:01:19.679 in the money markets, which is something that occasionally happens 0:01:19.800 --> 0:01:23.520 at quarter ends. That there's been a thing lately and 0:01:23.640 --> 0:01:25.720 people are sort of in the final few days of 0:01:25.800 --> 0:01:28.279 the final week or a couple of weeks of the quarter, 0:01:28.680 --> 0:01:31.360 you start to hear people rumbling about, are we gonna 0:01:31.400 --> 0:01:35.120 see um see stress appearing in various money market and 0:01:35.120 --> 0:01:39.000 fixed income markets, And I feel like I don't have 0:01:39.560 --> 0:01:44.160 my head completely wrapped around why this keeps happening. Ah, well, 0:01:44.200 --> 0:01:46.280 then I know just the person who's going to be 0:01:46.319 --> 0:01:49.360 able to help you with this. But yes, essentially, Uh, 0:01:49.480 --> 0:01:53.120 let's see at right before the year end, right before 0:01:53.160 --> 0:01:55.240 December thirty first last year, we did see a bunch 0:01:55.240 --> 0:01:58.480 of people talking about funding stress in the money market, 0:01:58.560 --> 0:02:01.520 which is just about the biggest money market that you 0:02:01.560 --> 0:02:03.960 can think of. And then just at the end of 0:02:04.000 --> 0:02:08.080 the first quarter we saw that yet again. So something 0:02:08.200 --> 0:02:11.800 is clearly happening in the market. At the same time, 0:02:11.919 --> 0:02:15.280 a big component of the money market, uh, something that 0:02:15.400 --> 0:02:18.200 is often used as collateral for the money market. US 0:02:18.280 --> 0:02:24.919 treasuries are also undergoing massive, massive changes, some of which 0:02:25.160 --> 0:02:27.840 you might have picked up on in the US. Once again, 0:02:28.000 --> 0:02:30.079 I feel like this is an area in which I'm 0:02:30.160 --> 0:02:33.240 extremely weak on, like a lot of the sort of 0:02:34.000 --> 0:02:37.160 the deep plumbing of the financial system I wish I 0:02:37.240 --> 0:02:40.919 knew more about, and I'm I'm optimistic that maybe I'll 0:02:41.000 --> 0:02:44.520 learn more after today's episode, Joe, I know you know this, 0:02:44.639 --> 0:02:47.040 So you know the U. S. Treasury is selling basically 0:02:47.120 --> 0:02:54.080 a record point thank you? Okay, a few Okay. So 0:02:54.120 --> 0:02:55.960 at the same time that the U. S. Treasury is 0:02:56.000 --> 0:02:58.760 selling a lot of debt, we have a bunch of 0:02:58.840 --> 0:03:01.799 changes sort of taking places in the underlying money market, 0:03:01.880 --> 0:03:04.120 and we're going to discuss all of those with someone 0:03:04.160 --> 0:03:08.840 who is really the foremost expert on this topic. So 0:03:08.880 --> 0:03:11.720 I'm very pleased that our guest for this particular episode 0:03:11.760 --> 0:03:15.079 is Reultan Posar. He's a strategist over at Credit Swiss. 0:03:15.120 --> 0:03:18.639 He's also a former US Treasury advisor, So who better 0:03:18.800 --> 0:03:21.880 to talk about the massive changes underway not only in 0:03:21.880 --> 0:03:24.120 money markets but also in the U. S. Treasury market 0:03:24.400 --> 0:03:26.360 result in, it's so good to have you on the show. 0:03:26.919 --> 0:03:29.960 Thank you very much for having me. So I sort 0:03:30.000 --> 0:03:33.639 of alluded to this, uh in the intro, but we're 0:03:33.639 --> 0:03:36.240 going to be talking about money markets and and just 0:03:36.320 --> 0:03:40.840 to back up for Joe's benefit, obviously, can you tell 0:03:40.920 --> 0:03:44.880 us what is your concept of money markets? What are 0:03:44.880 --> 0:03:47.520 we talking about when we say the money market? Thank you. 0:03:47.560 --> 0:03:49.760 I'm glad you asked this and didn't skip over this 0:03:49.840 --> 0:03:54.640 question because I would have. Yes, money markets, I think 0:03:55.760 --> 0:04:00.560 in my inserprevision, I think anything from overnight and introduced 0:04:00.600 --> 0:04:04.320 stuff out to I would say three months. And so 0:04:04.400 --> 0:04:10.040 that's the core of it. And you know money markets 0:04:10.040 --> 0:04:13.360 are hierarchical, and that that shows up in you know, 0:04:13.480 --> 0:04:16.279 the term aspect of it, the institutional aspect of it, 0:04:16.360 --> 0:04:18.520 the instrumental aspect of it. But I think the core 0:04:18.560 --> 0:04:21.760 of it is definitely all the flows that happened in 0:04:21.760 --> 0:04:25.919 the financial system three months and in so very short 0:04:26.040 --> 0:04:31.359 term funding. And the people who are buying and selling 0:04:31.440 --> 0:04:35.680 this short term funding, they're basically rolling over it constantly 0:04:35.880 --> 0:04:39.120 right in in the overnight market usually or through the 0:04:39.160 --> 0:04:42.840 repo market where they sort of use the underlying securities 0:04:43.000 --> 0:04:46.839 as collateral to secure extra financing. Yes, so so there 0:04:46.960 --> 0:04:50.400 is there is various types of players. Um, maybe we 0:04:50.440 --> 0:04:54.719 can start from outside in so you have you know, 0:04:54.720 --> 0:04:56.719 I guess the the every time you think about a 0:04:56.760 --> 0:05:00.680 carry trader, whoever is buying a bond and financing it 0:05:01.160 --> 0:05:05.080 short in the short term money markets. You know, Perry 0:05:05.120 --> 0:05:08.479 Merlin would say that they do money market funding of 0:05:08.560 --> 0:05:13.400 capital market landing another way of saying, shadow banking, carry trading, 0:05:13.600 --> 0:05:16.880 all that stuff. Uh, that typically gets funded at the 0:05:16.880 --> 0:05:22.279 three month point, simply because most bonds paid coupons every 0:05:22.400 --> 0:05:25.160 quarter and so it's convenient. I guess it's just an 0:05:25.200 --> 0:05:28.719 industry convention. So if you are someone who is not 0:05:28.760 --> 0:05:32.080 a dealer and who's not a bank, you will tend 0:05:32.160 --> 0:05:37.520 to fund the three month points. And there are obviously 0:05:37.520 --> 0:05:40.159 any other end of the spectrum. You have players that 0:05:40.279 --> 0:05:44.440 fund overnight. Those would be banks and dealers that have 0:05:44.960 --> 0:05:50.159 a deeper ability to roll this financing every day. And 0:05:50.200 --> 0:05:52.560 then the arbit treasures, I would say in the money 0:05:52.600 --> 0:05:55.680 market live between the overnight point and a three month point, 0:05:56.600 --> 0:05:59.479 because some of these arbitrast trades are about, you know, 0:05:59.560 --> 0:06:01.719 borrowing money for one months and lending it at the 0:06:01.720 --> 0:06:06.040 three month point and rolling it every three months I'm sorry, 0:06:06.080 --> 0:06:08.760 every month, or if you want to do shorter arm 0:06:08.839 --> 0:06:11.720 you can do one week to one month and one 0:06:11.800 --> 0:06:14.400 day to one week. And so you know, the three 0:06:14.400 --> 0:06:16.919 months and the overnight points are the extremes and and 0:06:17.040 --> 0:06:20.120 the large gesips or whatever you want to call them 0:06:20.160 --> 0:06:22.520 these days, they are the ones that move the money 0:06:22.560 --> 0:06:24.680 between the overnight point and the three month point. But 0:06:24.720 --> 0:06:28.000 all these ending that end users of funding tend to 0:06:28.080 --> 0:06:31.599 live at the three month points. So all these different 0:06:31.640 --> 0:06:35.960 players are engaged in different transactions, but essentially if they're 0:06:35.960 --> 0:06:39.200 borrowing at very short term rate for some sort of 0:06:39.279 --> 0:06:42.960 further trade, whether it's a lending or buying some bond 0:06:43.440 --> 0:06:46.400 out there that has a higher yield, how big and 0:06:46.440 --> 0:06:49.359 hoping the profit from the spread? How big is the 0:06:49.400 --> 0:06:52.599 money market? I mean, it's huge. It's uh, I never 0:06:52.680 --> 0:06:55.800 counted it. It's probably north of five trillion dollars. And 0:06:55.839 --> 0:06:59.880 then if you just look at the the large groups 0:06:59.880 --> 0:07:02.479 of investors that borrow in it, I mean the most 0:07:02.520 --> 0:07:07.000 obvious investor example is governments. The U S. Treasury they 0:07:07.080 --> 0:07:11.440 have um, you know, trillions of bills outstanding. You have 0:07:11.680 --> 0:07:14.080 the large banks, all of which now have to fund 0:07:14.640 --> 0:07:18.000 their so called h qul A portfolios around the three 0:07:18.040 --> 0:07:22.240 month points, so that's that's another trillion. You have the 0:07:22.280 --> 0:07:25.480 federal homeland banks in the US, which issue easily a 0:07:25.600 --> 0:07:30.560 trillion dollars um. The report market, we have daily statistics 0:07:30.560 --> 0:07:33.320 on it. It's at least a trillion dollars only at 0:07:33.320 --> 0:07:35.320 the overnight point, and the most of the report market 0:07:35.400 --> 0:07:38.240 is overnight anyway, So I think that's that's already around 0:07:38.280 --> 0:07:41.800 five trillion. And then The thing that's unmeasured, but it's 0:07:41.920 --> 0:07:44.520 very important and very huge is the f FX swap market, 0:07:45.120 --> 0:07:47.840 which is, you know, people think of it as a 0:07:47.880 --> 0:07:50.600 derivative and whatnot, but I mean, at the core of it, 0:07:50.600 --> 0:07:54.120 it's it's really a funding market. One thing we know 0:07:54.280 --> 0:07:58.200 is that in Tokyo alone, the dollar yen f swap 0:07:58.280 --> 0:08:01.960 market UM is roughly one and a half trillion dollars 0:08:01.960 --> 0:08:05.120 in size, or that's what it used to be at 0:08:05.200 --> 0:08:08.280 least UM through the end of twenty eighteen. The Bank 0:08:08.320 --> 0:08:12.119 of Japan they have a wonderful Financial Stability Report UM, 0:08:12.200 --> 0:08:15.120 and there's a chart they used to publish there where 0:08:15.120 --> 0:08:20.640 they broke down UH life insurers UM and large megabanks 0:08:20.720 --> 0:08:23.520 demand for dollars in the f S pop market UH 0:08:23.560 --> 0:08:25.760 and recently they stopped publishing it, but up to the 0:08:25.760 --> 0:08:28.360 point where they published that those numbers were north of 0:08:28.360 --> 0:08:30.680 a trillion dollars. And you know, the f FX spop 0:08:30.720 --> 0:08:33.960 market is big, not only in Tokyo, but also in 0:08:34.000 --> 0:08:37.400 Europe and in uh in you know Satellite Europe as 0:08:37.400 --> 0:08:41.600 I call it, you know, Switzerland, Scandinavia, all these other places. 0:08:41.640 --> 0:08:45.640 So I think the money market is easily north of 0:08:45.720 --> 0:08:49.040 five chillion probably even seven trillion dollars, all right, So 0:08:49.080 --> 0:08:51.839 it's it's a big market to say the least. There 0:08:51.880 --> 0:08:54.520 are going to be a lot of super relatives used 0:08:54.559 --> 0:08:57.240 in this particular chat. But Salton, I'm glad you mentioned 0:08:57.280 --> 0:08:59.560 the f X swap market. So this is basically the 0:08:59.559 --> 0:09:05.520 place where big investors hedge or convert their currencies. So 0:09:05.600 --> 0:09:08.880 you know, if you're buying US dollar debt and you're 0:09:09.080 --> 0:09:12.600 a Japanese investor, you probably don't want to be exposed 0:09:12.600 --> 0:09:16.160 to that currency risk, so you might do a swap 0:09:16.280 --> 0:09:19.960 um in the market to sort of offset that cost. Now, 0:09:20.120 --> 0:09:22.920 you argue that a lot of the flows that we've 0:09:22.920 --> 0:09:27.720 seen in money markets recently have been changing partly because 0:09:27.800 --> 0:09:30.040 of what's going on in the f X swap market. 0:09:30.120 --> 0:09:34.200 Can you explain that there's obviously always two sides of 0:09:34.360 --> 0:09:36.560 the same coin, right, So on the one hand, if 0:09:36.600 --> 0:09:41.400 you are a foreign investor, like a Japanese investor who 0:09:41.440 --> 0:09:44.560 buys dallar assets, it's not only that you don't want 0:09:44.600 --> 0:09:47.360 to have that dollar f X exposure, it's not in 0:09:47.400 --> 0:09:51.839 your mandate to run with that risk, right, So by 0:09:51.920 --> 0:09:55.440 mandate you basically have to manage the FX risk of 0:09:55.520 --> 0:09:58.280 that position. And eliminate it. And that's what you use 0:09:58.320 --> 0:10:01.839 the swap market for. And it's been, uh, it's been 0:10:01.880 --> 0:10:05.120 the case that for many years the primary destination for 0:10:05.160 --> 0:10:08.080 all these and again let's just you know, broaden this out, 0:10:08.120 --> 0:10:10.560 so this is not just about the Japanese life insurers. 0:10:10.559 --> 0:10:14.360 This is about Swiss life insurers, Swedish life insurers, Northern 0:10:14.400 --> 0:10:18.920 European UH long only pension funds and and and insurers. 0:10:18.920 --> 0:10:23.480 Whoever is basically trying to escape a negative rate jurisdiction 0:10:23.520 --> 0:10:27.160 at home has been playing a game where they have 0:10:27.240 --> 0:10:33.200 been looking for UH decently yielding assets, primarily in the 0:10:33.320 --> 0:10:36.840 US UH and then buying those assets and hedging it 0:10:36.880 --> 0:10:40.160 back to the local currency. And for as long as 0:10:40.200 --> 0:10:44.000 the curve treasury curve was steep in the US, that 0:10:44.080 --> 0:10:47.199 was an easy trade, right because if you could buy 0:10:47.240 --> 0:10:51.040 the tenure treasury at two and a half percent and 0:10:51.080 --> 0:10:56.080 pay UM one percent to hedge, the f X component 0:10:56.200 --> 0:10:58.480 of that of that bondy would still end up with 0:10:58.520 --> 0:11:01.400 one and a half percent, which compared to negative rates 0:11:01.400 --> 0:11:05.800 in the in the home country are great. UM. And 0:11:05.880 --> 0:11:08.640 you know, if you go back to twenty fifteen, that's 0:11:08.679 --> 0:11:11.520 been that's been the case. There were a couple of 0:11:12.120 --> 0:11:15.199 structural things that happened. I mean, number one, basiltry was 0:11:15.240 --> 0:11:19.160 obviously introduced, and that raised balance sheet costs for all 0:11:19.200 --> 0:11:23.520 the intermediaries that we're providing these effects edges to to 0:11:23.679 --> 0:11:26.880 the life insurance the world over. And then we had 0:11:26.880 --> 0:11:30.920 a couple of episodes of financial reform, like money fund reform, 0:11:31.120 --> 0:11:38.040 like tax reform, which messed around with the spread that uh, 0:11:38.200 --> 0:11:40.600 these foreign investors had to pay over O I s, 0:11:41.559 --> 0:11:44.679 which is basically the feds preferred path for short term 0:11:44.760 --> 0:11:50.360 rates UM. And and you know, sometimes these spreads periodically 0:11:50.360 --> 0:11:54.120 flared up and they raised hedging costs, but then hedging 0:11:54.160 --> 0:11:58.520 costs came back down after um. You know, these episodic 0:11:58.559 --> 0:12:01.719 storms have subsided. But the very important thing that has 0:12:01.760 --> 0:12:06.040 happened from twenty seventeen onwards is that the FED really 0:12:06.080 --> 0:12:09.160 started to hike interest rates. And as the FED started 0:12:09.160 --> 0:12:13.520 to hike interest rates, they flattened the curve completely. So basically, 0:12:14.520 --> 0:12:19.280 relative to three month bills, the tenure treasury barely yielded 0:12:20.040 --> 0:12:22.680 a lot more. And then when you add up these 0:12:22.760 --> 0:12:25.720 post basal three spreads on top of very elevated front 0:12:25.800 --> 0:12:28.080 and rates, you basically ended up in a situation that 0:12:28.280 --> 0:12:31.560 where if you're a foreign investor, you just cannot buy 0:12:31.600 --> 0:12:37.479 treasuries on a hedged basis and make a positive spread. Okay, 0:12:37.640 --> 0:12:40.720 And you know, this has also been a theme that's 0:12:40.720 --> 0:12:44.079 been going on for a while. And because treasuries were 0:12:44.080 --> 0:12:48.199 no longer attractive given hedging costs, another important theme in 0:12:48.240 --> 0:12:50.600 the US has been that all of the foreign flow 0:12:50.640 --> 0:12:53.720 has been going into the credit markets, anything from I 0:12:53.920 --> 0:12:56.560 G to high yield to c l os. So obviously 0:12:56.600 --> 0:13:01.520 that that helped, UH strong conditions in those markets, and 0:13:01.800 --> 0:13:05.760 you know, those assets trade at a reasonably you know, 0:13:05.840 --> 0:13:09.800 widespread the treasuries, and those widespreads were basically what offset 0:13:09.840 --> 0:13:16.040 the rising hedging costs. Do these uh foreign institutional investors 0:13:16.400 --> 0:13:19.840 um And you mentioned earlier that currency risk was not 0:13:19.960 --> 0:13:23.480 part of their mandate, How does the credit risk of 0:13:23.960 --> 0:13:27.120 buying corporates fit into their mandate? Credit risk is fine, 0:13:27.520 --> 0:13:30.160 that's no problem for them, right because you know, the 0:13:30.360 --> 0:13:33.280 thing about FX pop market, the FX markets is that 0:13:33.360 --> 0:13:35.680 you know, currency is gonna can go up and down, 0:13:35.840 --> 0:13:40.600 you know, five fairly easily. I think in the credit world, 0:13:40.600 --> 0:13:45.640 if you don't have anything systemic or anything sector specific, 0:13:45.679 --> 0:13:47.600 and for as long as you're diversified, and I mean 0:13:47.640 --> 0:13:51.920 it's very hard to get mark down. Is that big? 0:13:52.520 --> 0:13:57.160 So we've we Tracy started this or in the intro 0:13:57.280 --> 0:14:00.200 we talked about all of this, the weird stuff we 0:14:00.320 --> 0:14:03.800 keep seeing at the end of each quarter in these markets. 0:14:04.559 --> 0:14:07.760 And I'm what is that all about? So what what's 0:14:07.880 --> 0:14:10.880 changed such that the final several days of each quarter 0:14:10.960 --> 0:14:15.160 become this period where suddenly stressed starts to emerge. I 0:14:15.160 --> 0:14:21.560 think in simple terms, UM, we now have a regulatory 0:14:21.640 --> 0:14:27.800 regime which banks are following chapter and verse. And this 0:14:27.960 --> 0:14:34.160 regulatory regime has changed the economics of a bank's balance sheet. 0:14:34.360 --> 0:14:37.800 And there is certain days when you have to report uh, 0:14:37.840 --> 0:14:41.320 your leverage ratio. It used to be, you know, the 0:14:41.320 --> 0:14:43.840 focus used to be UNRISC created assets. Now this is 0:14:43.880 --> 0:14:46.440 just a simple leverage ratio where demotional size of your 0:14:46.480 --> 0:14:51.359 balance sheet cannot be bigger than x. You have liquidity ratios, 0:14:51.560 --> 0:14:56.040 term funding ratios, you have interday equidity requirements UM so 0:14:56.160 --> 0:14:58.400 called g CP scores, which means, you know, the bigger 0:14:58.400 --> 0:15:01.000 and the more complex you are, the more search arts 0:15:01.040 --> 0:15:05.520 you have to carry as capital in future periods. And 0:15:06.120 --> 0:15:14.680 you know, the the system takes these reporting dates extremely seriously. UM, 0:15:14.720 --> 0:15:18.280 and every time these deporting rates come come by, you know, 0:15:18.400 --> 0:15:22.160 quarter ends, year ends, year in particular, UM, banks just 0:15:23.120 --> 0:15:26.640 shrink their balance sheets because they have to meet certain targets. 0:15:26.960 --> 0:15:30.880 And when these balance sheets shrink, the market disappears, right 0:15:30.920 --> 0:15:33.000 because a lot of these markets that we're talking about, 0:15:33.160 --> 0:15:36.920 RIPO and f X pops are basically intermediated through banks 0:15:37.160 --> 0:15:41.560 balance sheets. UM. I think academics have this tendency to 0:15:41.560 --> 0:15:44.560 think about markets as some you know, magical cloud on 0:15:44.600 --> 0:15:47.480 a chart that always clears. I mean, there's nothing magical 0:15:47.520 --> 0:15:51.320 about them. It's basically people putting balance sheet on the line, 0:15:51.320 --> 0:15:53.200 and if they take that balance sheet away, you have 0:15:53.280 --> 0:15:56.120 a vacuum. And when you have a vacuum, great spot. 0:16:14.800 --> 0:16:16.880 So UM, I want to go back for a second 0:16:16.880 --> 0:16:20.200 to what we're discussing about how it's becoming more difficult 0:16:20.280 --> 0:16:24.880 for foreign investors to buy US treasuries. Uh this basic 0:16:24.960 --> 0:16:27.360 idea that you know, they used to be able to 0:16:27.360 --> 0:16:30.200 buy them and then hedge them and still make one 0:16:30.240 --> 0:16:32.640 and a half percent on something like the tenure, and 0:16:32.720 --> 0:16:37.120 now that's not possible, partly because the FED has raised rates, 0:16:37.480 --> 0:16:39.920 but also partly because of what's been going on in 0:16:39.960 --> 0:16:44.400 the FX swap market. How has that changed the body 0:16:44.880 --> 0:16:48.760 of buyers for US treasuries, How has that been different 0:16:49.000 --> 0:16:53.080 in recent months or years? And also why should we 0:16:53.240 --> 0:16:57.280 care about a different group buying up US treasuries as 0:16:57.280 --> 0:17:01.400 opposed to an old group like Japan these banks. So 0:17:01.440 --> 0:17:03.640 I'll tell you the punchline first. You should care about 0:17:03.640 --> 0:17:06.440 this because I think all of these impacts the FEDS 0:17:06.880 --> 0:17:10.760 ability to taper entering the balance sheet tremendously. And I 0:17:10.800 --> 0:17:13.840 think that that concept is is he'll understood. So let's 0:17:14.000 --> 0:17:16.639 let's start with the past and they will come to 0:17:16.680 --> 0:17:21.520 the present. So it's been the case that foreign investors 0:17:21.600 --> 0:17:25.320 used to be very you know, avid buyers of treasuries 0:17:25.760 --> 0:17:30.080 at auction and again for as long as the economics 0:17:30.119 --> 0:17:32.159 of it were there, you know, could buy treasuries and 0:17:32.160 --> 0:17:36.000 hedge it back for a positive carry. You did it. Um. 0:17:36.080 --> 0:17:39.680 What changed over the course of last year, and particularly 0:17:40.000 --> 0:17:43.920 during the fourth quarter of last year, the foreign buyers 0:17:44.480 --> 0:17:46.600 for all intents and purposes, you know, the bread and 0:17:46.640 --> 0:17:50.240 butter hedged buyers, they disappeared. Because what happened in the 0:17:50.280 --> 0:17:53.960 fourth quarter of last year, actually coming into the fourth quarter, 0:17:54.760 --> 0:18:00.720 is that the yield curve um outright inverted relative to 0:18:01.640 --> 0:18:07.560 foreign investors hedging costs. Okay, so I guess one important 0:18:07.600 --> 0:18:12.840 observation is that people tend to obsess over the inversion um. 0:18:13.000 --> 0:18:15.280 Then they tend to obsess about it in a way 0:18:15.280 --> 0:18:19.439 where they measure it using three stands, and actually, like 0:18:19.560 --> 0:18:22.800 looking at the curve shape using the three month bill 0:18:22.880 --> 0:18:25.680 yield versus the ten year yield actually is not very 0:18:25.720 --> 0:18:28.800 meaningful these days, because the reason why we did that 0:18:28.840 --> 0:18:33.040 metric ten years ago, when by uh that metric had 0:18:33.080 --> 0:18:35.639 meaning to it, was because everybody used to fund around 0:18:35.880 --> 0:18:38.120 the three month bill yield, and everybody used to fund 0:18:38.160 --> 0:18:40.040 around the three month bill yield because we didn't have 0:18:40.080 --> 0:18:45.000 Basil three. Bank balance sheets were an unlimited supply, so 0:18:45.040 --> 0:18:48.920 basically banks were arbitraging funding spreads all the way until 0:18:48.960 --> 0:18:51.879 they roughly equaled three month billiards. And that's obviously not 0:18:51.960 --> 0:18:56.640 the case anymore. So looking at curve slopes using three 0:18:56.680 --> 0:19:01.360 stands makes no sense. Under Basil three, what you need 0:19:01.400 --> 0:19:03.960 to do is actually you need to look at actual 0:19:04.040 --> 0:19:08.080 funding costs relative to the ten year point, and that 0:19:08.240 --> 0:19:11.880 those relative funding costs are term repo, three month lib 0:19:12.040 --> 0:19:15.280 or three month hedging costs, and all of these rates 0:19:15.280 --> 0:19:17.600 are going to be you can translate, as you know, 0:19:17.680 --> 0:19:22.399 three month bills plus twenty three month bills plus forty 0:19:22.440 --> 0:19:26.479 three month bills plus okay, and so those are your 0:19:26.480 --> 0:19:30.520 actual funding costom when you look at UM the level 0:19:30.560 --> 0:19:33.400 of these actual funding rates relative to the tenure, relative 0:19:33.440 --> 0:19:38.560 to all of them. The curve has inverted last October, 0:19:38.640 --> 0:19:41.040 the first week of October UM. And the reason for 0:19:41.119 --> 0:19:44.280 that was obviously you had the year and turn was 0:19:44.320 --> 0:19:47.600 getting priced into the FX pop markets UM, so you 0:19:47.640 --> 0:19:51.440 had a big pop in hedging costs. Library was going 0:19:51.480 --> 0:19:55.360 through its typical year and UH widening, which has been 0:19:55.640 --> 0:19:59.160 a mainstay of of of the post Bassal three regime. 0:19:59.200 --> 0:20:02.439 And you know, collateral supply and treasury issuance was heavy 0:20:02.760 --> 0:20:08.280 and that was pressuring GC rates. And so you know, interestingly, 0:20:08.680 --> 0:20:11.359 you know, even though the outright inversion only happened one 0:20:11.440 --> 0:20:14.760 or two weeks ago, relative to the rates that matter, 0:20:15.359 --> 0:20:19.280 we've been living in an inverted curve environment since last October, 0:20:20.040 --> 0:20:23.040 which I cannot find it important to highlight because sometimes 0:20:23.040 --> 0:20:26.040 you can still read fat speeches that say, while I'm 0:20:26.080 --> 0:20:29.680 not worried about the inversion just yet, because it only 0:20:29.760 --> 0:20:33.359 lasted two weeks, and I want to see deeper than 0:20:33.440 --> 0:20:36.080 what we can actually see in three stands. Well, actually 0:20:36.160 --> 0:20:39.400 it didn't happen only two weeks ago, but since last October, 0:20:40.000 --> 0:20:42.040 and depending on what funding rids you look at, it's 0:20:42.080 --> 0:20:46.200 been as deep as thirty or forty basis points. So 0:20:46.200 --> 0:20:49.040 so these things, these things are changing as we speak. 0:20:50.000 --> 0:20:53.399 So we are living through this inversion. And importantly, you know, 0:20:53.440 --> 0:20:56.879 to get back to your question, Tracy, when this inversion happens, 0:20:56.920 --> 0:21:01.320 you basically knock away a few by buyers potential buyers 0:21:01.440 --> 0:21:04.720 of treasuries. So if the foreign hatched buyer cannot buy 0:21:04.720 --> 0:21:09.160 this buy treasuries at auctions, then that's one buyer base 0:21:09.280 --> 0:21:12.600 that goes away. If you're a bank and you cannot 0:21:12.680 --> 0:21:15.159 fund that the three month point in the CD and 0:21:15.200 --> 0:21:18.000 CP markets and buy treasuries at a positive carry, you're 0:21:18.040 --> 0:21:20.320 not that buyer base away. So you just basically start 0:21:20.359 --> 0:21:25.600 to eliminate all the buyers that have been coming to 0:21:25.800 --> 0:21:29.040 the treasury market. But then there's a very special buyer base, 0:21:29.200 --> 0:21:33.280 which is the dealers who by law have to buy 0:21:33.320 --> 0:21:36.560 if nobody else buys um and that's what you do 0:21:36.640 --> 0:21:39.240 as a primary dealer. That's by auctions don't fail in 0:21:39.320 --> 0:21:43.040 the US at least and if nobody else buys, but 0:21:43.080 --> 0:21:45.679 the dealers have to. You know, the dealers don't have 0:21:45.720 --> 0:21:49.439 the money. The dealers are funded entities. And if you 0:21:49.520 --> 0:21:52.280 end up in a situation where you have to take 0:21:52.359 --> 0:21:57.560 down a large chunk of treasuries unexpectedly because the auctions 0:21:57.560 --> 0:22:00.840 go bad, then you basically need a lot of repo 0:22:01.040 --> 0:22:05.040 funding to take those treasuries downe and finance them. And 0:22:05.040 --> 0:22:07.679 that's precisely what happened during the fourth quarter of last year. 0:22:07.760 --> 0:22:10.680 You had this shock where you know, hedging costs and 0:22:10.720 --> 0:22:13.560 all these other funding rates got to on economic levels. 0:22:13.600 --> 0:22:16.840 The dealers had no choice but to take down the treasuries. 0:22:17.119 --> 0:22:18.639 They had no choice but to fund it in the 0:22:18.720 --> 0:22:21.959 report market. And basically the way that transpired was they 0:22:22.040 --> 0:22:26.320 leaned extremely heavily to a handful of large banks, and 0:22:26.400 --> 0:22:30.080 into those large banks hqu a portfolio, and they completely 0:22:30.119 --> 0:22:34.000 stressed out the report market because of that. So I 0:22:34.040 --> 0:22:36.320 guess before we get further into the details, I guess 0:22:36.480 --> 0:22:38.879 you know what I just told you about how this 0:22:39.000 --> 0:22:42.479 impact is the FEDS a bit of the taper. The 0:22:42.480 --> 0:22:45.080 The important thing here to appreciate is that once you 0:22:45.080 --> 0:22:47.520 get into overnight markets where these dealers tend to fund 0:22:47.520 --> 0:22:51.600 their inventories if you lean very heavily onto the onto 0:22:51.640 --> 0:22:54.640 the overnight repo market and you stress out rates there. 0:22:55.240 --> 0:22:58.160 Basically the way that manifests itself is that report rates 0:22:58.200 --> 0:23:01.520 are going to trade our outside the fat's target range 0:23:01.640 --> 0:23:06.080 for the overnight funds rate. UH and you know, as 0:23:06.080 --> 0:23:09.120 they like to call it, the constellation of short term 0:23:09.160 --> 0:23:13.399 interest rates. And you know, as a central bank, UH, 0:23:13.680 --> 0:23:16.800 the FED cares deeply about where overnight rates print relative 0:23:16.840 --> 0:23:19.080 to the band because that's one of the most important 0:23:19.080 --> 0:23:20.920 mandates you have as a central bank to make sure 0:23:20.960 --> 0:23:24.919 that that overnight rates print print within the target. And 0:23:24.960 --> 0:23:29.320 once you have difficulty in controlling that, then you you know, 0:23:29.640 --> 0:23:31.520 open up a whole new kind of worms. And that's 0:23:31.520 --> 0:23:33.879 what basically forces you to rethink how much you can 0:23:33.920 --> 0:23:38.080 actually taper, because whether report rates print within the band 0:23:38.200 --> 0:23:41.080 or outside the band ultimately come down to how many 0:23:41.119 --> 0:23:44.119 reserves there are in the system. Yeah, no, this is 0:23:44.320 --> 0:23:47.520 this is the part I think I could use and 0:23:47.880 --> 0:23:51.480 maybe some listeners could use a lot of clarification about, 0:23:51.520 --> 0:23:55.639 because obviously the fact that the FED is going to 0:23:55.840 --> 0:23:58.480 halt its wine down of the balance sheet this year 0:23:58.680 --> 0:24:01.760 is a very a lot of people talking about it 0:24:01.800 --> 0:24:05.560 without much understanding, and people like, oh, they're they they 0:24:05.560 --> 0:24:09.280 were stopping. They think maybe there's some I mean, it 0:24:09.320 --> 0:24:11.000 feels like the debate is like, oh, is this some 0:24:11.080 --> 0:24:14.040 economic thing or is this some technical thing? And it 0:24:14.080 --> 0:24:16.720 feels like a lot of people think of some economic 0:24:16.760 --> 0:24:18.920 thing where something is telling the Fed, oh, you can't 0:24:18.960 --> 0:24:21.640 keep winding it down, and the Fed is trying to say, no, 0:24:21.760 --> 0:24:23.879 this is just sort of we wanted to be boring. 0:24:24.000 --> 0:24:27.040 This is more of just about the sort of technical stuff. 0:24:27.080 --> 0:24:30.760