Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe. So Joe, it's uh, well,
Speaker 1: there's been a bit of drama in the treasury market
Speaker 1: once again. Yeah, I noticed. Um, you got to do
Speaker 1: one of your Tracy Elloway signature things where you talk
Speaker 1: about a move that happened that's always supposed to happen
Speaker 1: like once every three billion years. Yes. Um. I love
Speaker 1: talking about those because it really gives everyone the opportunity
Speaker 1: to show that they've read to Leb's books by saying
Speaker 1: that the world isn't normally distributed. But of course we
Speaker 1: did see some pretty big moves in the treasury market.
Speaker 1: So first of all, the ten year yield jumped up
Speaker 1: to one point six percent. This was in the last
Speaker 1: week of February. But the really big move came in
Speaker 1: the five five year and I think that one had
Speaker 1: something like a seven or eight standard deviation move, you know,
Speaker 1: one of those things that's only supposed to happen in
Speaker 1: like ten billion years kind of things. And really, I
Speaker 1: know people make fun of standard deviations and sigma events,
Speaker 1: but really we're talking about the world's most liquid market
Speaker 1: and stuff like this keeps happening. This is I think
Speaker 1: the fourth big about of treasury market chaos that we've
Speaker 1: had in just a couple of years. So I'm thinking back.
Speaker 1: We had one in um what was it September? We
Speaker 1: had Rebo madness, Then we had the March chaos in
Speaker 1: with the levered U S. T trades blowing up, and
Speaker 1: then we had a mini rates blowout in October, and
Speaker 1: now we just had the most recent incidents. So something
Speaker 1: is going on, and clearly there is a persistent issue
Speaker 1: in the U S. Treasury market. Yeah, there's a lot
Speaker 1: of things going on at once these day is because
Speaker 1: there seems to be ongoing structural issues, questions about liquidity,
Speaker 1: which is weird in a the world's most deep and
Speaker 1: liquid market, and be a market in which the FED
Speaker 1: is actively supplying a lot of liquidity, are very active
Speaker 1: in the market. And then of course it's interacting with
Speaker 1: the economic situation and the policy situation, because we have
Speaker 1: this FED that said we're not going to raise rates
Speaker 1: until the economy hits these benchmarks, and everyone's washing to
Speaker 1: see the FEDS credibility. We also have a very out
Speaker 1: rapidly improving economy. We have people warning about inflation for
Speaker 1: the first time, So all kinds of things happening at once.
Speaker 1: But yes, to your point, the big action we've seen.
Speaker 1: We've seen rates at the long end, ten year, thirty
Speaker 1: year yields have been rising for a while since the
Speaker 1: middle of last year, but it's really the action at
Speaker 1: the shorter end that's striking here. Yeah. And of course,
Speaker 1: one of the weird things about last week is you
Speaker 1: mentioned the economy, but we have this big tantrum in
Speaker 1: bond yields without a corresponding taper. I guess, so we
Speaker 1: kind of had a taperless tantrum because not that much
Speaker 1: changed last week. We didn't have FED speakers talking about
Speaker 1: rates rising or anything like that, but we have this
Speaker 1: huge move in the bond market. So a lot of
Speaker 1: focus on microstructure at the moment, a lot of focus
Speaker 1: on liquidity, ease of trading, and the overall organization of
Speaker 1: the treasury market. And we have the perfect person to
Speaker 1: talk about all those things. We're gonna be speaking with
Speaker 1: Sultan Posar from Credits with I can't wait, Let's do it. Yeah.
Speaker 1: Um so, Sultan, I should say, in addition to being
Speaker 1: a strategist over Credits, has also been on the All
Speaker 1: Thoughts podcast multiple times, so we will be getting you
Speaker 1: that tote bag any day now, Sultan, thank you so
Speaker 1: much for coming on again. Thank you very much for
Speaker 1: having me. I should just say one more thing, which
Speaker 1: is that every time there's any volatility in the rates market,
Speaker 1: someone I bas me it says, you guys got to
Speaker 1: get result on again. It happens every time anything takes
Speaker 1: higher on some screen of like overnight funding rates to
Speaker 1: whatever they're like, when do you have exulting back on
Speaker 1: the episode? So this is a lot of requests for
Speaker 1: this one. Sorry, go on. Okay, Well, on that note,
Speaker 1: I mean, why don't we start out with a big questions?
Speaker 1: So every time there's some sort of chaos in the
Speaker 1: rates market, Joe gets an I be asking for you
Speaker 1: to come on the show. There's been a lot of
Speaker 1: those over the past couple of years, and as we
Speaker 1: were discussing, that's something you wouldn't necessarily expect for the
Speaker 1: world's most liquid market. So what's going on here and
Speaker 1: why do we keep getting these sort of many blow
Speaker 1: ups in rates? I think people get shaken out of
Speaker 1: their positions all the time. I mean, just through just
Speaker 1: to me, who set the set the stage for the conversation.
Speaker 1: I think there's there's a number of things that are happening,
Speaker 1: um that has happened last week, for a number of
Speaker 1: weeks now and really since the Democratic win and the
Speaker 1: Blues the you know, the treasury curve has been steepening
Speaker 1: quite remarkably, I mean relative to uh the slope of
Speaker 1: curves in Germany, in France and Japan. You know, the
Speaker 1: U s treasury curve has gotten quite steep for a
Speaker 1: number of reasons. You had, you had the Blue sweep.
Speaker 1: You have the vaccine rollout, which is you know, happening
Speaker 1: in the US more rapidly perhaps than in other parts
Speaker 1: of the world. You have the market starting to price
Speaker 1: in recovery, the market trying to price in the inflation outlooks,
Speaker 1: and the market is you know, getting excited about the
Speaker 1: idea that with inflation, bill surely comes from that action,
Speaker 1: and that is going to you know, try to chase
Speaker 1: down inflation and keep it in check. And so all
Speaker 1: of these things I think have driven the steepening of
Speaker 1: the curve. But you know, the interesting thing is that
Speaker 1: the steepening of the curve has been fairly orderly, okay,
Speaker 1: And so what happened last week was a little bit
Speaker 1: plumbing related, but again the the the underlying structural driver
Speaker 1: of rising yields has been more fundamentally driven. What happened
Speaker 1: last week, I would say that there were two central
Speaker 1: banks that were quite a bit in the headlines um
Speaker 1: last week and and that got the markets a little
Speaker 1: bit kittery. I think there were some headlines around, uh,
Speaker 1: the r B n Z, and there were some headlines
Speaker 1: around the r B A, you know, with the r
Speaker 1: B and Z. I think what what didn't help the
Speaker 1: situation was the market interpreted the headline that the Finance
Speaker 1: Minister of New Zealand has forced a new mandate on
Speaker 1: on on the Reserve Bank of New Zealand because you know,
Speaker 1: house price targetting and house prices have been through the
Speaker 1: roof in New Zealand and so hikes are coming because
Speaker 1: of that, which is which is absolutely not the case.
Speaker 1: I mean, you know, the RBNZ is policy mandate is
Speaker 1: pretty much unchanged. I mean, they have their price stability mandate,
Speaker 1: they have their U full employment man, they have their
Speaker 1: financial stability mandate. And all that has happened is that
Speaker 1: that financial stability mandate getting more explicit peace to it,
Speaker 1: which is, you know, looking at house prices more carefully,
Speaker 1: um in the future, particularly house price dynamics driven by
Speaker 1: second home buyers and investment property buyers. That was number one.
Speaker 1: Number two UM, the r v A had breached a
Speaker 1: youth curve target, okay, and so the market was looking
Speaker 1: very closely at the three year point in the in
Speaker 1: the Australian government bond market and it got you know,
Speaker 1: one basis points to basis point three basis points higher
Speaker 1: than the yield curve target. And the RBA didn't truly
Speaker 1: do anything. And so because the RBA was so slow
Speaker 1: to respond to to to the breach of that youth
Speaker 1: curve target, UM, I think the market got quite spooked
Speaker 1: by that. You know, Australian accounts did try to get
Speaker 1: long Australian bonds, but you know, things were moving so
Speaker 1: fast and prices were getting so much that they got
Speaker 1: you know, limited down very quickly. So if you couldn't
Speaker 1: take advantage of the sellout in the US really and yields,
Speaker 1: what a lot of account in Austrailia have done is
Speaker 1: they have rather shorted US U S treasuries. And so
Speaker 1: now we are in a Tuesday Wednesday time frame, and
Speaker 1: then by the time we got to Thursday in the US,
Speaker 1: we had a scheduled seven year auction UM and that
Speaker 1: auction went absolutely horribly. It was, you know, one of
Speaker 1: the most undersubscribed in recent memory. I forget how far
Speaker 1: you have to go back to find something as lowly subscribed.
Speaker 1: And you know that also had some technical drivers do
Speaker 1: it because you know, in the US we are in
Speaker 1: this kind of Noman's land from a from a regulatory perspective,
Speaker 1: where the bank portfolios that are normally have a big
Speaker 1: presence in in these in these auctions have been a
Speaker 1: bit on the sidelines. Laterly because there's a big question
Speaker 1: mark in the US regarding you know, the SLR treatment
Speaker 1: of of treasuries. You know, is it going to get
Speaker 1: expended the exemption from the SLR or not um So,
Speaker 1: so there was a lot of uncertainty about that. And
Speaker 1: then you know you mentioned the five year point. I mean,
Speaker 1: it so happens that, you know, one a popular trade
Speaker 1: in the US has been you know, people shorting the
Speaker 1: five year and being short the five year and along
Speaker 1: the thirty year, and you know, as all these rates
Speaker 1: market dynamics were happening and the market was, you know,
Speaker 1: questioning central banks commitments to low rates for a long time.
Speaker 1: I think you know, people were just shaking out of
Speaker 1: these carry positions. And you know, we have a financial
Speaker 1: system that is highly levered because race are solo, right,
Speaker 1: so one way of generating a decent amount of return
Speaker 1: with low risk, low yielding assets as you lever it up,
Speaker 1: and every time you have a change in expectations and
Speaker 1: your understanding of the world and for how long the
Speaker 1: central banks are being to stay accommodative, you get shaken
Speaker 1: out of these positions and and things are quite volatible
Speaker 1: when it happens. So there's obviously quite a bit going
Speaker 1: on here, and I the way you laid it out
Speaker 1: is really great. And of course it seems like a
Speaker 1: classic finance thing that even though there's a lot of
Speaker 1: different things, somehow it randomly gets kicked off by policy
Speaker 1: choices at the Reserve Bank of New Zealand or the
Speaker 1: Reserve Bank of Australia and then it spills into their
Speaker 1: You mentioned the SLR and the questions about that, and
Speaker 1: in fact, some of the I V s that I
Speaker 1: get when they're like when they want to hear you
Speaker 1: on it's specifically about that what is it. I'm aware
Speaker 1: that something, some decision has to be made at the
Speaker 1: end of this month. It's going to affect bank liquidity,
Speaker 1: but sort of describe what this sort of this ambiguity
Speaker 1: that's hanging over the market is and how that is
Speaker 1: affecting UM rates, market liquidity. So this is a big topic.
Speaker 1: I'm you know, trying to think through how to attack
Speaker 1: the question. Okay, one, you know, you know there's lots
Speaker 1: of ambiguities, right, So you know, first of all, we
Speaker 1: have an exemption currently in place which says that you know,
Speaker 1: reserves just cast of central banks and treasuries that are
Speaker 1: bank holds are exempt from calculating the the supplementary leverage ratio.
Speaker 1: So this these leverage ratios are much higher because of
Speaker 1: that now, and that exemption UM was put in place
Speaker 1: in April one last year, and it's set to expire
Speaker 1: at the end of this month, March thirty one, and
Speaker 1: so no one knows whether it's going to get extended,
Speaker 1: whether it's going to be renewed temporarily or or if
Speaker 1: it's going to whether it's going to get extended permanently,
Speaker 1: whether it's going to get taken away. You know, a
Speaker 1: letter from Senator Brown and Senator Warrenberg in the headlines today, Um,
Speaker 1: you know they've sent them a letter to to the
Speaker 1: Federal Reserve arguing against making this exemption permanent. There are
Speaker 1: ideas that have been put forth by the Professor Daryl
Speaker 1: DARYLD Duffy at Stanford that you know, maybe only reserves
Speaker 1: should be exempted permanently, but not treasuries. That would be
Speaker 1: more in line with the global stand undered where you know,
Speaker 1: the ECB has exempted reserves, the SMB has exempted reserves,
Speaker 1: but that exemption by the way ended at the end
Speaker 1: of December. Already in the Bank of England exempts reserves,
Speaker 1: so that would be more in line with the international standard.
Speaker 1: But you know, the downside of that would be that
Speaker 1: you know, the banks would be forced to sell treasuries
Speaker 1: because you know, if your balance is constrained, um, and
Speaker 1: only reserves are exempt from the SLR, and you bought
Speaker 1: a lot of treasuries last year, then you will have
Speaker 1: to sell all those treasuries. So that's that's what this
Speaker 1: this uh, this uncertainty is. You know, when it comes
Speaker 1: to the SLR, really there's really two things that you
Speaker 1: want to think about the first is that we are
Speaker 1: not done with que and we are not done with
Speaker 1: you know, the wall of cash hitting the banking system. Right,
Speaker 1: So there's two things on the horizon that we are
Speaker 1: focused on. Number One, treasuries cash balances are coming down.
Speaker 1: I mean, you know, that's one point six trillion dollars
Speaker 1: of cash sitting in a in a in a bank
Speaker 1: account that at the at the Federal Reserve. And and
Speaker 1: as those balances come down, reserves in the banking system
Speaker 1: are going to go up. And number two, QUEE is ongoing,
Speaker 1: and it's a hundred and spenty billion dollars a month.
Speaker 1: So you know, at face value, if all the Treasuries
Speaker 1: cash banances come down to zero, and if QUI proceeds
Speaker 1: this year, we are going to be adding two to
Speaker 1: three trillion dollars of cash into the banking system. And
Speaker 1: so the banking system does not have the balance sheets
Speaker 1: to take on two three trillion dollars of cash without
Speaker 1: SLR relief, you know, so the thinking goes. And then
Speaker 1: the other problem is that you know, the ban on
Speaker 1: stock buy backs ended, and the banks are you know,
Speaker 1: getting ready to return capital to shareholders and and and
Speaker 1: if you. If you buy back stock and this SLR
Speaker 1: exemption does not happen, then you basically are in a
Speaker 1: position where the banking system is going to return and
Speaker 1: capital to shareholders that would otherwise have been used to
Speaker 1: take on more reserves and and and and treasuries in
Speaker 1: the in the system. So when we talk about this
Speaker 1: SELLR exemption, we kind of think about it as this
Speaker 1: magic bullet that's going to allow the banking system to
Speaker 1: take on two or three trillion dollars of reserves. So
Speaker 1: let's assume that the seller exemption happen. You know, this
Speaker 1: stellar exemption really matters for the for the handful of
Speaker 1: big banks that that really are key for for U
Speaker 1: S fiancial system. And these banks are JP Morgan, whilst
Speaker 1: Fargo City Bank, Bank of America I would perhaps put
Speaker 1: you know, P and C in the bucket as well.
Speaker 1: So these are these are the banks that are the
Speaker 1: big repositories of deposits and reserves and treasury securities, and
Speaker 1: they are the banks that have been underwriting the fiscal
Speaker 1: and monetary extension all of all of last year. So
Speaker 1: so let's assume that we do this SLR exemption. So
Speaker 1: what would happen. Would you know a bank like JP
Speaker 1: Morgan be in pole position to put on another five
Speaker 1: hundred billion dollars of reserves at the FED and another
Speaker 1: five billion dollars of deposits as the stimulus checks go out.
Speaker 1: The answer is no, because you know, JP Morgan has
Speaker 1: two constraints. It has an SLR constraint and it has
Speaker 1: a g SIP constraint. So even if you exempt reserves
Speaker 1: and treasuries from the SLR, you know that bank is
Speaker 1: still not going to be in a position to take
Speaker 1: on massive amounts of new deposits and additional reserves and
Speaker 1: additional treasury securities because that would push their GCIP score
Speaker 1: and their GIPS surcharged from four percent to four and
Speaker 1: a half percent. You know, and their management has repeated
Speaker 1: a number of times that they don't want to have
Speaker 1: a higher g SUP score and they don't want to
Speaker 1: higher capital ratio than's about an a half percent. Okay,
Speaker 1: so you know, SLR exemption or not, you know, JP
Speaker 1: Morgan is not in a position to take on a
Speaker 1: large amount of additional reserves. So that's number one. Number two.
Speaker 1: You know, well far ago the bank that I have
Speaker 1: been writing about a lot recently. Well Fargo is is
Speaker 1: in a unique situation because they are under an asset
Speaker 1: growth ban okay, and they have been put into that
Speaker 1: place because of you know, past issues they have had
Speaker 1: and a SAD has put them in in this asset
Speaker 1: growth band position. So you know, the the analogy there
Speaker 1: is if you if you think of the US financial
Speaker 1: system as a seven for seven, a Boeing seven for seven,
Speaker 1: it's really had been. It really has been flying on
Speaker 1: three engines because the fourth engine, you know, it's just
Speaker 1: not working at the moment. That that's well Fargo. You know,
Speaker 1: if you have an SLR exemption, you're still not going
Speaker 1: to help wellth Fargo because they can't grow their balance
Speaker 1: sheet much, okay. So that's that's the second bank. The
Speaker 1: third City Bank is you know, it's a unique creature,
Speaker 1: right because it's half global, half US. It's mostly an
Speaker 1: institutional bank, not a retail bank, so it doesn't have
Speaker 1: as big a retail present as as JP Morgan or
Speaker 1: Bank of America. So you know, all the stimulu structs
Speaker 1: are going out and all these cashes coming into the system.
Speaker 1: You know, they're the posit growth is you know, not
Speaker 1: going to be uh as big as it would be
Speaker 1: for JP Morgan and Bank of America. And you know
Speaker 1: the other thing about cities that they have slatlined their
Speaker 1: balance sheet since the third quarter of twenty twenties, so
Speaker 1: they haven't really been growing their balancie that much. Then
Speaker 1: we have Bank of America, which is a bank that
Speaker 1: would absolutely benefit from an SLR really because they don't
Speaker 1: have a GC issue like UM JP Morgan UM. And
Speaker 1: you have you know, PNC Bank, which is which is
Speaker 1: a large regional bank when you would say probably borderline
Speaker 1: national bank because it's so big, and so you basically
Speaker 1: have two banks that would be the primary beneficiaries of
Speaker 1: of an SLR relief. Then you need to stop there
Speaker 1: because every time the SET makes a decision about SLR
Speaker 1: relief and all these changes to the Basle three architecture,
Speaker 1: they do something called a impact study, and the aim
Speaker 1: of this impact studies to basically um quantify you know,
Speaker 1: what type of a quantity benefit does the system get
Speaker 1: by doing this route change. And you know, if you
Speaker 1: come to the conclusion that of all these large banks
Speaker 1: that we're trying to help, we are only going to
Speaker 1: benefit one or two, not the entire class of Jesives,
Speaker 1: should we really do this or be getting a lot
Speaker 1: of mileage out of out of sl release. And I
Speaker 1: think you know the answer there is is not really
Speaker 1: because again you are going to be looking at five
Speaker 1: banks and really only two of them are going to
Speaker 1: be able to absorb a lot of reserves and treasuries.
Speaker 1: And when you look at the scale of things to come,
Speaker 1: you know, to the three trilli and a additional liquidity,
Speaker 1: you know, it's clear that even those two banks are
Speaker 1: not going to be able to absorb all of that liquidity,
Speaker 1: you know. So, so observation number one, you know, how
Speaker 1: do you justified when when the when the universe of
Speaker 1: banks that can benefit from this on scale, your ability
Speaker 1: to add balance capacity to the system is is not
Speaker 1: that big to begin this. I think that's definitely one
Speaker 1: thing that they are going to uh they are going
Speaker 1: to look at the second because you know, everything that
Speaker 1: we talked about is basically about how do you absorb
Speaker 1: the additional cash that's going to come into the system
Speaker 1: this year. The second aspect of of it is is
Speaker 1: this um the ALAR exemption is is very important from
Speaker 1: the perspective of stock buybacks. Right, so a lot of
Speaker 1: these banks will say, um, we have a lot of
Speaker 1: excess capital, and what that means is that they have
Speaker 1: a lot of excess capital relative to res created assets. UM.
Speaker 1: You know, rescreated assets are basically loans and you know
Speaker 1: the bank's credit portfolios, but loans have not really been
Speaker 1: growing and the banks has had a stock by back
Speaker 1: band that has been in place since the first So
Speaker 1: basically all all net income that the banking system has
Speaker 1: been generating for the past twelve months has been retained
Speaker 1: UM and you know that added to banks capital base.
Speaker 1: So uh, you know, when the banks are saying that
Speaker 1: we have a lot of access capital, that access capital
Speaker 1: relative to risk weated assets, but it's not access capital
Speaker 1: relative to all the reserves and the treasuries that have
Speaker 1: been accumulated last year. As as the fiscal and monitor
Speaker 1: stimulus get under way, and so you know, slur exemption
Speaker 1: there is essential for the banks to be able to
Speaker 1: start returning some of this excess capital UM two shareholders.
Speaker 1: But again, you know that's a capital return aspect and
Speaker 1: not necessarily that will make it easier for the banks
Speaker 1: to return capital shareholders, but it won't necessarily add you know,
Speaker 1: balance the capacity to to to the system, and I
Speaker 1: think that's why this makes it so complicated as a
Speaker 1: decision for the FAD. So I guess to two related questions.
Speaker 1: One during the February bond market drama, like, how much
Speaker 1: did SLR concerns way on dealers, um in your opinion?
Speaker 1: And I know that you like to call around a
Speaker 1: lot of the banks and sort of pick up market
Speaker 1: color when these things happen, So I'm just curious how
Speaker 1: much that came up. And then secondly, what could the
Speaker 1: FED do to sort of relieve balance sheet pressures instead
Speaker 1: of extending the SLR if you think that it's not
Speaker 1: necessarily the most efficient way of doing that. Okay, Well, um,
Speaker 1: I think I think the way last week in the
Speaker 1: treasury market and and and the SLR question are related.
Speaker 1: It's actually not through not through the dealer balance it's
Speaker 1: it's basically the bank portfolios that you want to think about, right, So,
Speaker 1: every every large US bank is going to have a
Speaker 1: dealer subsidiary and what's called the bank operating subsidiary, and
Speaker 1: it's the banks that have all the reserves and all
Speaker 1: the treasuries. The dealers have obviously a treating book that
Speaker 1: but that in a grand scheme of things that that's tiny.
Speaker 1: So when you look at an auction that goes bad, okay,
Speaker 1: a large part for that that auction is basically because
Speaker 1: the bank portfolio doesn't show up, because the bank portfolio
Speaker 1: doesn't know what's going to happen to this SLUR exemption.
Speaker 1: You know, management is getting the balance is ready for
Speaker 1: stock by backs. If you want to buy that stock
Speaker 1: you basically and an SLR exemption does not happen, then
Speaker 1: you will be you know, throwing balance with capacity away
Speaker 1: to basically carry liquid assets. And if you do that,
Speaker 1: you know, it's much better to do that when you
Speaker 1: have less treasuries and more reserves. So you know, the
Speaker 1: the the the SAR exemption angle here is just basically,
Speaker 1: you know, had this a stellar exemption being resolved already
Speaker 1: and and if we have clarity on it, and you
Speaker 1: know maybe if had you know, extended permanently, you know,
Speaker 1: then the banks would have been I guess more present
Speaker 1: at the auction and so things would not have gone
Speaker 1: um that that you know what happens with with again,
Speaker 1: you know, the these these carry traders getting shaken out
Speaker 1: of their positions. You know, the dealers are going to
Speaker 1: kind of intermediate these things. But you know, in real time,
Speaker 1: I guess you know, you always have these air pockets
Speaker 1: that the dealers have to intermediate to. And when the
Speaker 1: flows go one way and then quickly the other way,
Speaker 1: I mean, it's never a smooth process. But I would
Speaker 1: not say that, you know, dealers intermediation capacity was impaired
Speaker 1: by any means, because because of these SLR deliberations, it's
Speaker 1: more like a bank portfolio. Do I show up at
Speaker 1: the auction and takedown of treasuries or or not? He
Speaker 1: had a second question, trat, but I forgot, but that
Speaker 1: was Oh. So the second question was if the SLR,
Speaker 1: If extending the SLR exemption isn't the most efficient way
Speaker 1: of fixing this problem, what could the FED or regulators
Speaker 1: do instead? Again, I think, I think you have to
Speaker 1: you have to go back to QUEI one and QUEI
Speaker 1: Q one too. Que E three. You know that two
Speaker 1: thousand and eight to twenty fifteen period to see how
Speaker 1: the system absorbs liquity. Uh that's put in by central banks.
Speaker 1: You know. The reason why I bring up Q one
Speaker 1: to que E three is the stats balance. It expanded
Speaker 1: back then a great deal too, but half of the
Speaker 1: liquidity went to the large American banks and the other
Speaker 1: half has gone to the foreign banks. What makes last
Speaker 1: year an anomaly is that all of this liquidity that
Speaker 1: was punned into the system went to the American banks,
Speaker 1: and it stayed with the American banks. You know when
Speaker 1: you look at you know, the for foreign banks holdings
Speaker 1: of reserves at the said it's been largely flat. Okay,
Speaker 1: So you you now basically have two case studies where
Speaker 1: you know, we have a big downpour of liquidity, it's
Speaker 1: all going to the American banks, and then we have
Speaker 1: another downpour of liquity earlier in history where half of
Speaker 1: we spent here, half aw spent there. What is going
Speaker 1: to happen if the American banks are going to have
Speaker 1: balanchet constraints, Well, the system is going to adjust. Um.
Speaker 1: You know the stimulus checks that are going to come in, Uh,
Speaker 1: those are going to be hitting people's bank deposits. You know,
Speaker 1: these are all retail deposits that every bank loves. And
Speaker 1: you know when the stimulus checks go out, you know
Speaker 1: it's obviously going to be JP Morgan and Bank of
Speaker 1: American and and all these big national banks that are
Speaker 1: going to be getting it. But that's going to put
Speaker 1: them in a position where if they have a fixed
Speaker 1: quantum of balance sheets, because that's a lot really doesn't happen,
Speaker 1: then they are going to have to take a hard
Speaker 1: look at their deposit base and say, okay, well we
Speaker 1: are getting good retail deposits. We have some institutional deposits
Speaker 1: to some of it operating, some of it non operating,
Speaker 1: non operating. It's basically access cash that these institutions just
Speaker 1: parked with these large banks. And then you know, the
Speaker 1: bank is going to be in a position where they
Speaker 1: are going to have to turn some of these institutional
Speaker 1: deposits away. There's a number of ways to to doing that.
Speaker 1: I mean, you're basically dealing with corporate treasurers, so you
Speaker 1: know you will pick up the phone and try to
Speaker 1: negotiate with them. You know, I can't really hold it
Speaker 1: in the bank, but would you mind moving it over
Speaker 1: to my asset management arm and putting it into a
Speaker 1: money fund or if that doesn't work, you can't put
Speaker 1: a put a fee on you know, these deposits. Some
Speaker 1: of the banks are doing this already. Um, I'm not
Speaker 1: going to mention hich Bank, but one bank, for example,
Speaker 1: in January started to charge institutions for the posit balances
Speaker 1: that are above their December thirty starts level. And you know,
Speaker 1: there's just applied way of saying that, Look, if you
Speaker 1: place more cash with me, there will be a fee
Speaker 1: associated with that. So you know, that's that's one way
Speaker 1: of encouraging depositors to move cast from one bank to another,
Speaker 1: or from from the banking system too to to two
Speaker 1: money fund. And then the third thing you're gonna do
Speaker 1: is you're going to move your deposit trade negative. And
Speaker 1: you know this is not this is not theoretical because
Speaker 1: if you look at um JP Morgan's fourth quarter learnings presentation,
Speaker 1: you know they have a very interesting slide on this
Speaker 1: that you know, we we are now approaching balance sheet constraints.
Speaker 1: We have all these deposits coming in. The only assets
Speaker 1: really we can deploy these deposits into is cash at
Speaker 1: the FED which earned stand basis points. Or we can
Speaker 1: buy treasuries, which you know, at the tenure point it
Speaker 1: yields great, but otherwise, you know, treasuries are not not
Speaker 1: really a good good investing opportunity. And thanks to begin that,
Speaker 1: they're not very excited about dying treasuries and you know,
Speaker 1: these are all very low r OV type activities UM
Speaker 1: and low r o E means you know, you're diluting
Speaker 1: your your bank's performance. And you know, if you have
Speaker 1: a fifteen percent r o WE target and all the
Speaker 1: balance sheet growth that you're getting is happening in the
Speaker 1: in the in these low spread assets, then you basically
Speaker 1: dial with your your banks r o WE. So you know,
Speaker 1: the point of this this page in the learning presentation
Speaker 1: was that for us to improve the economics of our business,
Speaker 1: given all this downpour of liquidity and the system expansion
Speaker 1: that the set is forcing on the banking system, we
Speaker 1: will have to move or de consitrates negative because that's
Speaker 1: the way that we are going to be able to
Speaker 1: meet our our earning s targets. And so you know,
Speaker 1: when you bring in this negative the consit traits idea
Speaker 1: into the picture, then you know the the the picture
Speaker 1: you know, starts to fall together because what's happening here
Speaker 1: is that as the licutity comes in and the banking
Speaker 1: system becomes balance sheet constrained, they are pushing the money
Speaker 1: away into money funds and the bill market because not
Speaker 1: everybody is going to want to invest in in money funds.
Speaker 1: And so you know, the the idea of negative bill yields,
Speaker 1: which is, you know, a regime where we are that
Speaker 1: your borderline in already. You know, this regime of negative
Speaker 1: bill yields goes hand in hand with negative deposit traits
Speaker 1: or fees on bank deposits because you know, there's so
Speaker 1: much cash to the banking system just doesn't want to
Speaker 1: hold it. And you know that money is getting pushed
Speaker 1: around in the system and we are just trying to
Speaker 1: find home for it. And you know, I'm giving you
Speaker 1: a very long winded answer, but basically, what are what
Speaker 1: is the technology to basically deal with this? You know,
Speaker 1: technology quote unquote. You know, we have a tool for this,
Speaker 1: which is the reverse report facility. Right, all the money
Speaker 1: that is going into the money funds, I mean, the
Speaker 1: money funds need an asset to invest this catch into.
Speaker 1: And so you know, really it would be as simple
Speaker 1: as whatever the money the banking system doesn't want and
Speaker 1: the money fund get, the money fund should be able
Speaker 1: to place in the reverse rey pro facility one for one.
Speaker 1: But there's one problem with this reverse rey port facility.
Speaker 1: It's capped at thirty billion dollars per counterparty, which means
Speaker 1: that if you're a large money fund and you have
Speaker 1: fifty billion dollars of inflots coming at you, because you know,
Speaker 1: Jping Morgan just pushed away fifty billion dollars of deposits,
Speaker 1: you will only be able to put thirty billion of
Speaker 1: that in the reverse rey pro facility, and that remaining
Speaker 1: twenty you will be investing at rates below that, you know,
Speaker 1: potentially at negative interest rates. You know, then the money
Speaker 1: funds can get into a situation where if I can
Speaker 1: invest at negative rates only my marginal inflows, I'm not
Speaker 1: going to want that money because you know, money fund
Speaker 1: is not supposed to break the buck, and not breaking
Speaker 1: the buck is is possible only if yields in your
Speaker 1: investment universe or above zero. So a number of money
Speaker 1: funds that you talked to the especially the larger ones,
Speaker 1: are contemplating gating inflows and basically shutting the door to
Speaker 1: new money. And then you get into a dynamic where
Speaker 1: the bank doesn't want to get the money, the money
Speaker 1: fund doesn't want to get the money. So then the
Speaker 1: bill market remains this kind of alternate shock absorber that's
Speaker 1: going to take the inflos, and that's how you get
Speaker 1: to negative bill yields basically between now and in the
Speaker 1: beginning of summers. What is it that the SET can do.
Speaker 1: The SET could simply uncap the use of this RRP facility,
Speaker 1: and I think that would go a great length to
Speaker 1: to ensuring that there is a flexible supply of asset
Speaker 1: for the money fund complex where you can invest cash
Speaker 1: at least at zero Or you know, the FED wants
Speaker 1: to raise the the r A P rade from zero
Speaker 1: to five basis points, then you have a marginal asset
Speaker 1: for for the for the money fund complex that pays
Speaker 1: five basis points. And then and then you don't have
Speaker 1: any of these issues. And you know, that's why I
Speaker 1: have been arguing in in my in my recent pieces
Speaker 1: that far more important than raising the price on the
Speaker 1: reversaryport facility is to uncapt the use of that facility,
Speaker 1: because you know, if you can only place x amount
Speaker 1: of five at five basis points, once you're beyond that amount,
Speaker 1: you will be lending cash at rades less than five
Speaker 1: basis points. And you still get into this dynamics that
Speaker 1: it's talking about. So we've been talking a lot about plumbing, obviously,
Speaker 1: and this is sort of, uh, the key story and
Speaker 1: the issue of like where to put all this extra
Speaker 1: cash and the lack of vehicles to place it. You know,
Speaker 1: we just have we have a few minutes left before
Speaker 1: we go. I want to get back to something. You
Speaker 1: know in your first answer, we talked a little bit
Speaker 1: also about positioning and how low rates the only way
Speaker 1: to compensate for low rates is leverage. Some of the
Speaker 1: issues with Australian investors having to short the U S.
Speaker 1: Treasury market to sort of hedge the fact that the
Speaker 1: the belly of the Australian curve was blowing out. Let's
Speaker 1: go back a little bit to that, and how much
Speaker 1: is that part of the story of this sort of
Speaker 1: concentrated positioning um C t A flows uh. And how
Speaker 1: much is that part of the story that we've seen,
Speaker 1: and how much of that is still built up? How
Speaker 1: much pent up sort of tension is there? And how
Speaker 1: much is that dissipated with last week's shock. Look, I
Speaker 1: think I think a lot of it has. The positions
Speaker 1: have shrunk, right, so short of the belly along the
Speaker 1: back end, I think those positions have been downsized, um
Speaker 1: relative to last week. I think I think we also
Speaker 1: had this again this episode of you know, what's how
Speaker 1: committed our central banks to keeping you know, in the
Speaker 1: case of the r B a rates in the belly anchored.
Speaker 1: And I think you know, the central banks have spoken
Speaker 1: loud and clear. You know, the ECB has spoken loud
Speaker 1: and clear about you know, they don't want any of
Speaker 1: their yields going higher. Either. The set hasn't really said anything.
Speaker 1: And frankly, you know, I don't think I don't think
Speaker 1: that they should. I mean maybe even even I was
Speaker 1: I was a bit too fast last week, you know,
Speaker 1: saying that, Well, one thing that the fest could do
Speaker 1: is a talk rates down, do something like an operation twist,
Speaker 1: you know, self front and stuff and buy back and
Speaker 1: stuff to the police belong and but but here's the point,
Speaker 1: you know, the long and you don't really need to
Speaker 1: police because what you have seen is that you have
Speaker 1: this massive sell off. But then you know, the the
Speaker 1: the fics hedged bys that we talk a lot about
Speaker 1: on this show, at least when I come on, is
Speaker 1: you know, they are now getting a beautiful amount of
Speaker 1: slope in the treasury curve. And and again keep in
Speaker 1: mind every time you talk about all these cash coming
Speaker 1: into the system, you know, Bill yields going negative. That
Speaker 1: means that these hedging costs are going to be very
Speaker 1: well anchored and if anything, they are going to be
Speaker 1: going going lower. So basically, you know the sell off
Speaker 1: that happened last year, you know, some guys were shaking
Speaker 1: out of their positions, but that was an opportunity for
Speaker 1: another set of buyers because if you look at these
Speaker 1: effects hedged yields, I mean we are back to levels
Speaker 1: where we had last time, being in twenty fifteen. And
Speaker 1: you know that's just great because you know when you
Speaker 1: look at yields in Japan and you look at yields
Speaker 1: in Europe, I mean those are still abysmal. Right, So
Speaker 1: any fixed income allocator is going to look at these
Speaker 1: types of sell offs um with great excitement. And that's
Speaker 1: that that was a part of the self healing mechanism.
Speaker 1: And you know, on Thursday we had a bad day,
Speaker 1: but Friday and since then we've been having uh you know,
Speaker 1: great great price section in in treasury. So again, you know,
Speaker 1: some people win, some people lose, But I don't think
Speaker 1: that that the sets should do anything about this. And again,
Speaker 1: you know, I think I think there will be a
Speaker 1: couple of these um instances where you know, as the
Speaker 1: inflation narrative and the reflation narrative is not going to
Speaker 1: go away anytime soon. You know, that's going to drive
Speaker 1: field curve dynamics. I think you know that's that's a
Speaker 1: part of the that's a part of the future out
Speaker 1: But I'm not sure that you know, the said should
Speaker 1: do anything explicit about it. I think, you know, even
Speaker 1: even I think I even regret saying, let's be that,
Speaker 1: you know, one of the things that the pet should do,
Speaker 1: they talk it down, be do operation twist im And
Speaker 1: sometimes you get bound up in the emotions of the markets.
Speaker 1: You know, the market has theres a lot of you know,
Speaker 1: self healing properties, right and again, you know, the losses
Speaker 1: for some investors were an opportunity for the ATHLETs buyers
Speaker 1: later on, you know, on Friday, and and and that's
Speaker 1: so far to seek. So I want to go back
Speaker 1: to the start of our discussion and just talk very
Speaker 1: very broadly about the strength of the U. S. Treasury
Speaker 1: market in terms of actual structure and the plumbing. We've
Speaker 1: seen these instances where liquidity seems to evaporate, and you know,
Speaker 1: last week wasn't necessarily as bad as what we saw
Speaker 1: in March, but we did see bid ask spreads on
Speaker 1: treasuries start to blow out. How concerned are you about,
Speaker 1: I guess the structure of the treasury market or liquidity
Speaker 1: within the treasury market generally. You know, I think I
Speaker 1: think it's a philosophical question. I think, you know, markets
Speaker 1: are not supposed to be about no volatility at all.
Speaker 1: In fact, I think is a is a healthy phenomenon.
Speaker 1: And you know, I just don't think moves that we
Speaker 1: have seen last week. I mean, again, you know, markets
Speaker 1: go from one extreme to another. But but for as
Speaker 1: long as there is a you know, mechanism whereby some
Speaker 1: value based investory is going to provide an outside spread
Speaker 1: and put a lid on things, that's great. And I think,
Speaker 1: you know what, what what I think happened less weak
Speaker 1: is actually you know, I tend to focus on, you know,
Speaker 1: the self healing properties of the market, and from that perspective,
Speaker 1: I think that the market work fine. It's just that
Speaker 1: you know, some leveled players were shaken out of their
Speaker 1: position because you know, the market perception of of how
Speaker 1: committed central banks or two to keeping rates low has
Speaker 1: has changed. And then you know, central banks basically when
Speaker 1: the other way, and and and and the market the
Speaker 1: market calm down, So you know, I wouldn't point to
Speaker 1: you know, there's too much regulation and that's why the
Speaker 1: market is creating this way, or or or any of that.
Speaker 1: I think. I think it's just it's just a healthy development.
Speaker 1: I mean, it's not comfortable, especially if you're on the
Speaker 1: wrong side of trade. But I don't think, but I
Speaker 1: don't think that that we should be going um down
Speaker 1: a path where, you know, we need to redesign the
Speaker 1: treasury market because there is occasional basketball activity in it. Well, Sultan,
Speaker 1: I think that's a great place to leave it, and
Speaker 1: we could always talk to you for a few hours.
Speaker 1: Thank you so much for coming on. We appreciate it.
Speaker 1: Thanks that was really great. Thank you very much for
Speaker 1: having me, guys, so Joe. It's always great having Sultan on.
Speaker 1: And his explanation of the price action last week was
Speaker 1: probably the clearest one that I've seen so far. And
Speaker 1: you know, a lot of people were sort of freaking
Speaker 1: out about this being a central bank miscommunication or the
Speaker 1: taper tantrum re ducts, but actually, like if anything, it
Speaker 1: resembled a sort of technical shift in positioning as levered players,
Speaker 1: you know, rethought their bets. Yeah, there's always a lot
Speaker 1: of when rates move violently, you know, we can't really
Speaker 1: help but ascribe some sort of deep economic significance to them,
Speaker 1: and people love narratives about all the bond market is
Speaker 1: challenging the FED or inflation or maybe something with fiscal policy,
Speaker 1: and I guess that's always there to some extent, and
Speaker 1: perhaps um this sort of the difficulties in communication that
Speaker 1: maybe the the Antipodaean central banks have had in New
Speaker 1: Zealand and Australia kicking things off, they've had sort of
Speaker 1: problems with communicating about their medium term rate path. But
Speaker 1: in the end, like when you have a bunch of
Speaker 1: people who are all levered into sort of roughly the
Speaker 1: same positioning, and you have these other clouds hanging over
Speaker 1: the market, such as the questions about the SLR that
Speaker 1: a long described you can just get stuff. It doesn't
Speaker 1: always necessarily have to have sort of meaning per se. Right,
Speaker 1: It's sort of the the game stop equivalent for the
Speaker 1: treasury market. Sometimes things just happen, yeah, and it doesn't
Speaker 1: necessarily mean no, that's the decab I actually thought about
Speaker 1: it with respective games stop it's like something sometimes things
Speaker 1: just happened, and just in the same way everyone was like, oh,
Speaker 1: this is class warfare or this says something about T
Speaker 1: plus two. It's like, yeah, but sometimes things just happened
Speaker 1: in market. Um, what was I gonna say? Oh? Yeah.
Speaker 1: I also thought it was great that Salton kind of
Speaker 1: I mean, just on the point about the bond market
Speaker 1: challenging the Fed, which was a narrative that we saw
Speaker 1: come out in some commentary next week. You know, the
Speaker 1: Fed can't control the bond market. The bond vigilantes have
Speaker 1: returned that sort of thing. I thought it was really interesting. Um,
Speaker 1: that's old, and basically said that he regretted writing last
Speaker 1: week that the FED could do an operation Twist or
Speaker 1: something like that to keep a cap on bond deals.
Speaker 1: Like he sort of admitted that he was caught up
Speaker 1: in the moment and that things have changed. But but
Speaker 1: that's like it's not something that you hear from a
Speaker 1: lot of analysts necessarily that sort of honesty. No, totally right.
Speaker 1: And also this idea, it's like, look like, bonds are
Speaker 1: not equities and they do have, as he pointed out,
Speaker 1: this sort of um natural curve mechanism and we have
Speaker 1: gotten to the point where there's steepness in the curves
Speaker 1: such that for foreign FECs hedged buyers there is now
Speaker 1: value there. A new set of bidders comes in. So
Speaker 1: you know, with a cut, with a with game stop,
Speaker 1: you can have an extremely long period of time in
Speaker 1: which the underlying in which the value of the security
Speaker 1: is extremely divorced from anything resembling fundamentals. And it really
Speaker 1: seems much harder to have that. It's why it's hard
Speaker 1: to like really even imagine what like a treasury bubble
Speaker 1: would mean, because you do have these sort of natural
Speaker 1: buyers that come in at certain levels. If you get
Speaker 1: a disconnect, and disconnects do happen between fundamentals and raids
Speaker 1: very quickly, Uh, new sources of money emerge in one
Speaker 1: direction or another, and you don't get the movie going
Speaker 1: on forever. I just had a great idea for a
Speaker 1: financial market novel, which would be, you know, a scenario
Speaker 1: in which Wall Street bets tries to take on the
Speaker 1: treasury market and force a squeeze. That'd be interesting. Twenty
Speaker 1: one trillion dollar market versus creditors. Maybe we should write
Speaker 1: a novel together. We've we've never been able to come
Speaker 1: up with a good idea for a like proper finance
Speaker 1: book together. Maybe the answer is a novel. Let's just
Speaker 1: go the fiction route. I'd be up for you. All right, okay,
Speaker 1: this has been another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Halloway and I'm Joe wi Isn't though. You can
Speaker 1: follow me on Twitter at the Stalwart. Follow our producer
Speaker 1: Laura Carlson on Twitter. She's at Laura M. Carlson. Followed
Speaker 1: the Bloomberg Ahead of podcast Francesca Levie at Francesco Today,
Speaker 1: and check out all of our podcasts at Bloomberg under
Speaker 1: the handle at podcasts. Thanks for listening.