Lookout, there's a dollar crunch!
As Zoltan Pozsar of Credit Suisse warned a couple of weeks ago, the combination of a glut of safe assets in the market, plus a Fed still intent on keeping monetary policy tight, has been feeding through to repo markets in the form of volatility.
But now we have this (hat tip to Marc Ostwald from ADMISI for the chart):
That’s a relatively wild spike in US general collateral repo rates to as much as 8.25 per cent at the open, at a bid/offer spread of 9.0%/7.50%.
This is seismic stuff — and possibly indicative of a real dollar crunch — not least because it’s not even the quarter’s end (the usual time funding squeezes emerge).
Therefore something else must be driving the dash for cash.
Repo focused analysts such as TD Securities’ Priya Misra and Gennadiy Godberg note the market is blaming a combination of things including the corporate tax date (which creates a demand for liquidity), bill supply, coupon settlements and GSE cash as potential reasons for the spike.
But since much of that should already have been priced in — and this is the third time repo rates have spiked to abnormally high rates the past year — they, in line with Pozsar’s thinking, are blaming structural factors. And, in particular, a general scarcity of bank reserves:
Reserves have been declining since 2014 and we expect them to decline further as Treasury's cash balance increases and currency in circulation grows. The spike in repo affects the transmission of monetary policy and we expect the Fed to take the spike in repo rates seriously. A standing repo facility can greatly help, but we don't think that the operational details have been sorted out yet. An IOER cut or limiting the foreign reverse repo facility will only help at the margin.
While all of that is probably true, it still doesn’t add much insight on what the real trigger for the repo spike has been.
Alphaville has one highly speculative theory, which we invite more informed readers to scrutinise and debunk if needs be. (Although, our readers never require much invitation.)
We previously argued Monday’s oil price spike constituted a pretty unprecedented state of affairs and could conceivably lead to a lot of fallout for those caught on the wrong side of the move — evidence of which would only come to light in the days to come.
So one theory is that a dash to post variation margin at the respective commodity exchanges (and in cleared bilateral markets as well) is in some ways feeding through to a funding shortfall in repo markets.
As we noted previously, a lot of the buyside were likely caught short due to the seemingly popular theory that the trade war would lead to a slowdown in oil demand.
Even if such funds closed down their positions entirely, yesterday’s move was so large it is more than likely initial margins might have been blown through entirely, leaving many exposed to raising the difference owed to the exchanges elsewhere (under legal obligation).
But the other bigger theory is that the strikes have taken out approximately $400m in daily dollar cash income for the Saudi government. That income equals dollar liquidity the Saudis suddenly no longer have access to. Their dollar spending commitments, however, go unchanged. If commitments to pay salaries and suppliers can’t be met by (what were until now fairly predictable) cash injections from oil sales, the only other option for the Saudis is to start liquefying their dollar asset reserves . . . and that, very likely, is something to be conducted through the repo markets directly.
In which case repo markets may be moving in anticipation of Saudi liquidity operations — in the context of a market that’s already being over supplied in terms of safe government bond assets relative to available bank reserve liquidity — or as a result of them already taking place.
Opinions and counter theories welcome below. We’d be especially keen to hear what repo market practitioners are seeing and hearing.
The Fed is already taking action. Here’s the NY Fed’s latest statement:
In accordance with the FOMC Directive issued July 31, 2019, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York will conduct an overnight repurchase agreement (repo) operation from 9:30 AM ET to 9:45 AM ET today, September 17, 2019, in order to help maintain the federal funds rate within the target range of 2 to 2-1/4 per cent.
This repo operation will be conducted with Primary Dealers for up to an aggregate amount of $75 billion. Securities eligible as collateral in the repo include Treasury, agency debt, and agency mortgage-backed securities. Primary Dealers will be permitted to submit up to two propositions per security type. There will be a limit of $10 billion per proposition submitted in this operation. Propositions will be awarded based on their attractiveness relative to a benchmark rate for each collateral type, and are subject to a minimum bid rate of 2.10 per cent.
Scratch that! The operation has been cancelled due to technical difficulties. It’s all getting a bit crazy. (Let’s hope they weren’t using blockchain).