Global Money Notes #26 Countdown to QE4
Comment of the Day

January 06 2020

Commentary by Eoin Treacy

Global Money Notes #26 Countdown to QE4

Thanks to a subscriber for this edition of Zoltan Pozsar’s money market notes for Credit Suisse. Here is a section:

Eoin Treacy's view

Here is a link to the full report and here is a section from it: 

The Fed’s FX swap lines would get around the G-SIB problem directly – if market making in the FX swap market breaks down due to G-SIB-related bottlenecks at large banks, flows get kicked higher up in the hierarchy and central banks become market makers in FX swaps and lend dollars to banks in their jurisdictions at a price of OIS + 50 bps…

…so that the world does not stop spinning.

That response would deal with the potential problems in FX swap markets above head on, and ensure that the reserves taken by a select group of dealers from the repo facility around year-end flow into the repo market to fill the funding needs of RV hedge funds.

QE4 would help through the backdoor: by reversing the mistake of balance sheet taper. QE4 would mean buying back from dealers and banks the Treasuries they were forced to buy during balance sheet taper and giving back the reserves they gave up in the process.

QE4 would re-liquefy HQLA portfolios by trading Treasuries for excess reserves…

the excess reserves that were always needed to get through to year-ends seamlessly, and which the system’s liquidity profile and U.S. banks G-SIB scores need desperately.

QE4 would re-fill the Bakken Shale in an instant… as primary dealers stuck with Treasuries would pay off their repos with J.P Morgan, and that would bring us back to the natural state of the token system, that is, a state, where the distribution of excess reserves is uneven once again, and where J.P. Morgan is the system’s lender of next-to-last resort once again. Why is that better than the Fed?

Because J.P. Morgan has the right set of pipes: it lends into FICC and the Fed does not.
Because J.P. Morgan is pragmatic: it buys coupons when it has to and the Fed does not.

QE4 – as much as it makes sense – won’t happen unless the Fed’s hands are forced…

and not responding to potential stresses in the FX swap market with the swap lines, may be what forces the Fed’s hands. If it will take the swap lines to help RV hedge funds to roll their positions without the risk of fire sales, not encouraging their use pre-emptively can lead to fire sales where QE4 goes live as a clean-up “operation” with the Fed buying what the RV funds are forced to sell – and what they could have bought from dealers under normal circumstances as dealers have been politely asking the Fed since September, just like they were asking for a repo facility before that – and we know how that ended…

The surge in repo rates was not a blip. It was the result of a combination of factors that conspired to drain liquidity from a vital part of the financial system. The solution has been for the Fed to step in as lender of first and last resort because traditional market makers are constrained by regulation and requirements to hold higher cash reserves.

The provision of a standing repo facility has not been announced, but the Fed’s actions in avoiding the worst-case scenario laid out in the above report (dated December 9th) suggest that it has already provided that facility. This creates unlimited liability for the Federal Reserve and suggests the balance sheet will continue to expand until QE4 is in fact announced. The absence of yearend stress in the repo market is probability the result of a more than $400 billion increase in the size of the Fed’s balance sheet. More than any other fact that is responsible for the reasonably steady trading in stock markets despite geopolitical tensions.

All maturities below about 8 years are below the Fed Funds rate. That signals bond market investors are less than convinced by the Fed’s belief it will not have to cut in 2020. This is another example of the mismatches that have arisen from the liquidity issues in the repo market. The Fed is now the de facto central banker to the world and that is helping to keep yields under wraps. The provision of liquidity appears to be a medium-term trend.

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