Zoltan Sparks Treasury Dump, Says Fed “Foaming Runway” For SLR End
While much of the financial commentariat spent Wednesday afternoon focusing on the Fed’s useless dot plot (which focuses on a period that takes place about a year after Powell’s tenure at the Fed is over and he will be replaced by uber-dove Brainard), we pointed out a “huge surprise” (as Curvature’s repo expert Scott Skyrm put it) contained deep inside the statement – the Fed’s decision to hike the Reverse Repo counterparty limit from $30 billion to $80 billion.
Why was this significant? Because as Skyrm explained, “if the Fed wanted overnight rates higher, they would have raised the IOER and/or RRP. Instead, they raised the RRP counterparty limit” which also “implies the Fed is very comfortable with zero percent rates and maybe even negative rates.“
In other words, having seen the recent drops of overnight GC repo into the red…
… and 1 month bills trading as low as -0.01% this morning, the Fed decided to do nothing.
However, as that “other” repo guru, Zoltan Pozsar (formerly of the NY Fed and currently at Credit Suisse) pointed out later on Wednesday, there is another possible interpretation, a much more ominous one for those who believe that banks need an SLR exemption now, or else they will be forced to raise capital/delever/dump treasurys – in other words, lead to even more pain for Treasurys.
Zoltan begins by laying out his big picture view on the The Fed’s decision to raise the counterparty cap of the o/n RRP facility today from $30 to $80 billion, stating it was “the right move to deal with the “tsunami” of reserves that was finally unleashed this week with the disbursement of stimulus checks.”
Echoing Skyrm, Zoltan then correctly notes that while the adjustment is not quite the same as uncapping the overnight RRP facility, it’s very close, “and the Fed showed a willingness today to raise counterparty caps further if need be.”
What Pozsar says next however, is quite debatable in light of the current negative prints in 1 month bills. The repo experts claims that this “adjustment will ensure that U.S. money market rates won’t trade negative and that money funds don’t face a collateral shortage that would force them to gate inflows and deflect institutional flows to the bill market.“
We beg to differ: why? Because one look at the chart of 1 Month T-bill today, shows that the market disagrees …
… and no matter Pozsar’s conviction, which judging by the following is quite high…
Today’s adjustment also means that hikes to the IOR and o/n RRP rates won’t be necessary: rightly, the Fed fixed a quantity problem with a quantity solution; as we’ve been arguing this year, adjustments to the IOR and o/n RRP rates would have been plain ineffective to deal with the problem of too much cash relative to banks’ capacity to warehouse it and collateral supply to absorb it.
… the market obviously does not think that merely hiking RRP counterparty limits by $50BN will be enough to offset the flood in reserves.
But it’s what Zoltan said next that is what may have spooked bond traders:
In our view, the fact that the Fed made this adjustment practically preemptively – the o/n RRP facility is not being used at the moment, so there are no capacity constraints yet, while repo and bill yields aren’t trading negative yet – suggests that the Fed is “foaming the runway” for the end of SLR exemption: ending the exemption of reserves and Treasuries from the calculation of the SLR may mean that U.S. banks will turn away deposits and reserves on the margin (not Treasuries) to leave more room for market-making activities, and these flows will swell further money funds’ inflows coming from TGA drawdowns.
This – as we have explained repeatedly – is a problem. It’s an even bigger problem because it was Powell’s soothing words during the FOMC Q&A that eased the market’s frayed nerves yesterday when he said that he will “announce something on SLR in coming days“, which immediately pushed yields to post-FOMC lows and sparked a surge in stocks to new all time highs.
Needless to say, Pozsar’s hint that the Fed’s SLR announcement will not be an extension of the SLR relief but an outright elimination, was problematic to markets which now view SLR relief as critical to proper functioning (and plumbing) and took the overnight selloff in rates sparked by a Nikkei story that the BOJ would allow long-term interest rates to move in a slightly larger range of about 0.25%, plus or minus, versus 0.2% now, and pushed it into overdrive.
Yet what we find ironic, is that the schizophrenic market is now relying on Pozsar’s forecast for the fate of the SLR even as it ignores his far more benign take on how negligible the impact of the SLR has been (and will be if it is eliminated), as he explained in a note from Tuesday.
Finally, how to determine if Zoltan is correct? He concludes his note by writing that “given that our call for a zero-to-negative FRA-OIS spread by the end of June was predicated on the end of SLR extension and an assumption that the Fed will try to fix a quantity problem with prices, not quantities, today’s adjustments mean that FRA-OIS won’t trade all the way down to zero or negative territory.”
FRA-OIS from here will be a function of how tight FX swaps will trade relative to OIS, but Treasury bills trading at deeply sub-zero rates is no longer a risk…
Considering that Bills are trading at subzero rates (maybe not too “deep” but certainly deep enough to be dubbed negative), the market seems to be split: on one hand it believes Zoltan that the SLR will end, but refuses to believe him that no SLR relief will not have an adverse impact on risk, something which the surge in 10Y yields and plunge in risks has made quite clear at least in the early hours of trading.
Thu, 03/18/2021 – 09:41