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Guest Post: Thoughts On The GC-IOER Collapse

Tyler Durden's picture




 

From Atlantic Capital Management

The GC-IOER collapse is far more significant than many people realize.  The dynamics of the repo market are not always easy to understand, but somehow I don’t think that is the reason it has received zero attention outside of ZeroHedge.

ZeroHedge’s coverage has rightly focused on the liquidity implications for Wall Street institutions and the overall repo market.  There is also the push to get money funds out of repo and in to the regulated banking system through deposits.  While these are certainly significant issues in and of themselves, I think there is an arguably more substantial aspect that has not yet been uncovered.

In Tyler’s last post on the subject, May 18, he quoted Barclays Joseph Abate:

“We believe this will increase the premium to general collateral at which these issues trade and make it harder to cover shorts.” [emphasis added]

For those unfamiliar with the repo market, it has a number of essential functions.  Chief among them is its mechanism to cover short positions in fixed income securities.  If the special collateral rate is negative, as the May 18 post indicated it was for a third of all UST repos, then the moneylenders that are short on UST positions cannot find enough physical bonds to cover them.  Shortage of this magnitude is often a function of hypothecation. 

The answer to the counterintuitive question of why someone would lend money at negative interest rates is that the moneylender’s first priority is to cover that short position.  As the special rate deepens in the negative or persists there for a period of time, the pressure on the moneylender to cover grows exponentially. 

This type of negative collateral lending rate is currently on full display in the silver market, where forward rates have persisted at negative levels since April 21 (before that in February & March).  Silver forward rates are nothing more than another form of collateralized loan, very much akin to special collateral repo trades.  When forward rates are negative, the demand to cover short physical positions forces the moneylender to pay out interest because they need to cover more than they need to earn a positive rate. 

The longer the negative interest penalty for being short remains, the more pressure there is to exit the short position.  It is a self-reinforcing feedback loop since the short covering forces prices higher, leading to more losses for holding short positions, etc. 

From the perspective of the Federal Reserve, what better way to “influence” interest rates on the longer end of the yield curve, particularly if rates are trending in the “wrong” direction.  There is no evidence that the Fed colluded with the FDIC to change the GC-IOER carry dynamics, but a look at interest rates since early April shows a happy Fed.

Tyler’s first post, dated April 5, coincided with a top in five-year treasury yields.  In that post Tyler reported a sharp downturn in repo rates, with GC hitting 6 bps.  He followed that up with a post on April 12 where GC rates fell to the ridiculous 1 bp level.  Since special rates are below GC rates, we can safely conclude that most securities “on special” were at negative rates.

Again, “coincidentally”, the ten and thirty-year treasuries both topped out the day before the GC rate fell to that low level.  Yields across the longer end have been falling ever since.  Could this simply be the Fed pushing rates lower through forced short covering in the repo market? 

The Fed doesn’t mind playing with fire (in this case liquidity) since it’s history is littered with ill-conceived interventions.  We know there is pretty strong circumstantial evidence that the Fed is concurrently trying to influence rates through volatility (see ZeroHedge http://www.zerohedge.com/article/did-fed-its-stealthy-synthetic-bet-keep-yields-low-become-next-aig). 

We also know that any decrease in demand for treasury shorts would negatively impact treasury auctions.  This seems counterintuitive, but shorts do their work in on-the-run securities.  In 2002, the Federal Reserve studied this phenomena and concluded:

“Dealers sell short on-the-run Treasuries in order to hedge the interest rate risk in other securities.  Having sold short, the dealers must acquire the securities via reverse repurchase agreements and deliver them to the purchasers.  Thus, an increase in hedging demand by dealers translates into an increase in the demand to acquire the on-the-run security (that is, specific collateral) in the repo market.” i

The demand for the on-the-run securities by short traders keeps demand high at auction.  So, the more treasury shorts there are, the greater demand at auction time (we studied this in March 2010 and concluded this would be one of the prime factors keeping rates low after QE 1.0 ended.  Everyone in the world was convinced rates would move far higher, yet they never did as auction after auction showed increasing and bewildering strength – the demand for shorts was keeping the auctions well subscribed).

Conversely, in April and May 2011, the forced short coverings have led to less than enthusiastic auctions.  Again, from the Fed’s perspective, these are slightly negative indications for interest rates, but it more than makes up for them by running the shorts out of the repo market.

I would like nothing more than to offer conclusive proof that this is the case.  However, absent any smoking gun, there is certainly enough coincidences to warrant giving this more thought.  Treasury rates may be declining on their own (I personally doubt it), but given the timing of these moves it is not hard to imagine that the Fed and its regulatory cousins gave treasury rates a powerful shove in the “right” direction

 


i  “Special Repo Rates:  An Introduction”, Mark Fisher.  Federal Reserve Bank of Atlanta, Economic Review, Second Quarter 2002, Page 27.
http://www.frbatlanta.org/filelegacydocs/fisher_2q02.pdf

 

 

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Thu, 05/19/2011 - 23:32 | 1294482 gwar5
gwar5's picture

Yep, strange days indeed. There are no free markets anymore. We've all looked. 

Thu, 05/19/2011 - 23:44 | 1294510 bigelkhorn
bigelkhorn's picture

I do not think there has ever been free markets. it is just that now people have just woken up to this fact...i guess

I subscribe to the guy from australia and his FFT economic newsletter at http://www.forecastfortomorrow.com  that guy has called many big events before they have happend, including the stock market crash in 2008 and the current financial collapse of the US. (currently happening) I found him from a friend last year, and he has some important work.

His oil calls are insane, and I have been making good money with them. He is well worth a look, if you want to keep two steps ahead of the sheeple out there.

I am worried about my financial future. Is anyone else nervous out there?

Fri, 05/20/2011 - 02:27 | 1294767 oh_bama
oh_bama's picture

COULD SOMEONE PLEASE EDUCATE ME WHAT

"GC-IOER" IS?

 

 

Fri, 05/20/2011 - 04:14 | 1294815 AUD
AUD's picture

GC is general collateral repo rate, IOER is apparently the interest rate on some particular Fed Funds. GC-IOER is the spread between the two.

What does it mean? Fucked if I know. I already asked last night & got nothing but a couple of obtuse responses. This article seems to be saying there is a short squeeze in Treasury bills but I could be wrong.

Fri, 05/20/2011 - 07:21 | 1294909 oh_bama
oh_bama's picture

Many thanks. Guessing IOER means interest rate on excess reserves ?

Fri, 05/20/2011 - 08:04 | 1294956 Jack Sheet
Jack Sheet's picture

The authors don't know either.

Fri, 05/20/2011 - 08:18 | 1294979 I am more equal...
I am more equal than others's picture

So the short squeeze keeps interest rates low - at least temporarily - making the bubble bigger.  Can we play the same game?  Short RMBS and stop paying your mortgage. Enough people do that and you got a serious money making trade. 

Fri, 05/20/2011 - 04:24 | 1294812 Highrev
Highrev's picture

Yep, strange days indeed. There are no free markets anymore. We've all looked. 

It's all manipulation any more, right down to the last man, and the most despicable imaginable. One need look no further than Spain.

 

General Elections 2004: The Socialists were trailing badly in the polls, then we got a terrorist attack in Madrid days before the election that the Socialists blamed on the incumbent government’s involvement in Iraq, employing an agit prop strategy that mobilized the radical left and managed a narrow victory that allowed them to govern in minority, withdraw from Iraq, start the Alliance of Civilizations, and make friends with Hugo Chavez and the like.

General Elections 2008: The Socialists were trailing badly in the polls, and then we got another terrorist attack days before the election that was once again manipulated to gain minority control.

Municipal and Autonomous Elections 2011: The Socialists were trailing badly in the polls, then we got . . . well, it would be just too coincidental to get another terrorist attack, don’t you think?  So this time around we’ve got “botellón ideológico” encouraging the populace TO NOT vote (and we all know how that turned out in Venezuela, don’t we?).

The “Spanish Revolution” will disappear into thin air the day after the elections as though it never existed as the participants return to their comfortable free loader lives in their parent’s homes, and the socialist controlled mainstream press looks for another circus act to put on the air.

(If you take away a rather negative opinion of the Socialists from this, remember the first 3 paragraphs are simply the facts ma’am, and after next Monday we’ll be able to say that about the 4th too.)

 

 

 

Fri, 05/20/2011 - 07:07 | 1294896 moneymutt
moneymutt's picture

your socialists seem to be as socialist as socialist as China's communists, if they have had control over your countries fate and your FIRE industry ran amok, they aren't very good socialists, and I'm sure getting out of the Iraq war lead to your real esate bubble and 20 percent unemployment

Thu, 05/19/2011 - 23:38 | 1294502 bob_dabolina
bob_dabolina's picture

Wow. 

You could have just said.....

June 15th....which will be the day.

Fri, 05/20/2011 - 07:41 | 1294923 jus_lite_reading
jus_lite_reading's picture

Hardy and true but so few understand what is going on and how dynamic the markets should be. Even some ZHers have become complacent to this fact because of how long this giant dried up sponge has actually lasted... but no more. The Fed is the buyer of only resort. From this standpoint its already "Game Over" as TD posted yesterday. I am closely following this situation because interest rates across the board can and will literally explode. Look at Greece for a sample of whats to come in a few weeks. Hell we might have days remaining before the real SHTF...

Thu, 05/19/2011 - 23:55 | 1294527 mophead
mophead's picture

"The GC-IOER collapse is far more significant than many people realize."

Almost everything is more significant than we realize. Take for example, the common house fly. Nothing special right? But without them, most spiders in your house won't survive, and if the spiders don't survive, then they won't scare you, and if they don't scare you, then good horror movies won't be produced and discretionary spending will go down, and the system will collapse. Everything is connected: money, bitches, etc. Anyhow, here's what all this doom and gloom will get you today: SHORT STOPPED/SQUEEZED/HUGE LOSSES. My $.02.

 

Fri, 05/20/2011 - 07:45 | 1294928 jus_lite_reading
jus_lite_reading's picture

Sounds like someone got caught on the wrong side of the trade and is bitter. Boo hoo loser.

I focused one two things over the past two years and me is happy as Ellen Degenerate in Rosie O'Donnel's shower. 

Thu, 05/19/2011 - 23:50 | 1294538 JW n FL
JW n FL's picture

Look if the FED shorts Long to keep short term low.. come Saturday, InfiniTimmy and Ben-O-cide will be in Heaven! with Blank-check-man! for All doing God's Work here on Earth.. so No Worries!

Fri, 05/20/2011 - 00:04 | 1294551 Boston
Boston's picture

"we studied this in March 2010 and concluded this would be one of the prime factors keeping rates low after QE 1.0 ended.  Everyone in the world was convinced rates would move far higher, yet they never did"

Note the key word---AFTER QE ended.  Well, QE2 hasn't ended yet.  Does this mean that the BIG move---down---in  Treasury rates is yet to come?

 

Fri, 05/20/2011 - 00:04 | 1294557 Boston
Boston's picture

.

Fri, 05/20/2011 - 00:19 | 1294589 Miles Kendig
Miles Kendig's picture

We also know that any decrease in demand for treasury shorts would negatively impact treasury auctions.

Looks to be the same way Kyle Bass was able to amass his short positions in RMBS

Regardless if this is live or memorex the fact remains that we're considering the potential.  There are all sorts of reasons the fed would want to squeeze this segment.

Fri, 05/20/2011 - 00:29 | 1294613 bigwavedave
bigwavedave's picture

Repo market is being primed for taking in the unwinding of the Fed balance sheet. Hence the cmpression. Already more than 30 market funds have been added to the system. The other majors (perhaps 200 total) will be added in the next 90 days or so.

There is of course madness in this logic. Spilling balance sheet assets into Money Market funds is one way to boost the NPL holdings of most pension accounts. Did you really think they would stuff longer dated paper into your IRA via the front door?

 

 

Fri, 05/20/2011 - 08:02 | 1294954 Mec-sick-o
Mec-sick-o's picture

One of the (unintended?) consequences of not marking to market accounting.

Fri, 05/20/2011 - 00:31 | 1294616 Hephasteus
Hephasteus's picture

"This type of negative collateral lending rate is currently on full display in the silver market, where forward rates have persisted at negative levels since April 21 (before that in February & March).  Silver forward rates are nothing more than another form of collateralized loan, very much akin to special collateral repo trades.  When forward rates are negative, the demand to cover short physical positions forces the moneylender to pay out interest because they need to cover more than they need to earn a positive rate."

/thread

 

Fri, 05/20/2011 - 01:18 | 1294683 Urban Redneck
Urban Redneck's picture

A repeat of 2008 MM issues would not serve the FED well.  The funds represent real liquidity and while making the short end of the curve unattractive may drive a greater percentage of cash into the long end of the Treasury curve or wherever the FED or Treasury happen to please on a given day , it will also increase demand for non-Treasury yield alternatives.  By making one element of the shadow banking system unattractive- other areas are made more attractive in addition to regulated alternatives.  So if it works, until it doesn't, do we get MMMF 2 to go with QE 3A repeat of 2008 MM issues would not serve the FED well.  The funds represent real liquidity and while making the short end of the curve unattractive may drive a greater percentage of cash into the long end of the Treasury curve, it will also increase demand for non-Treasury yield alternatives.  By making one element of the shadow banking system unattractive- other areas are made more attractive in addition to regulated alternatives.  So if it works, until it doesn't, do we get MMMF 2 to go with QE 3?  If so, the ESF might need to be enlarged this time. 

If these fools were so good and skilled at playing God with the economy there actually would be an economic boom in the US by now.

Fri, 05/20/2011 - 02:55 | 1294787 bigwavedave
bigwavedave's picture

this logic pre supposes that what is good for the economy is good for the Fed. Simply not true based on historical trends.

There a many calls on ZH for people to wake up. But the reasoning is never defined for the average person to make sense of. There is either esoteric micro economic analysis or total doom mongers and PM nutjobs.

The facts are clear. The history is clear.

The last remaining store of wealth in the USA is savings and pensions. Those monies need to be matched against the liablities being (or been) incurred.

The global picture is equally simple. Buy foreign made stuff you dont need and your kids dont work. Simple. Henry Ford new this. You cannot out price your market.

The current housing deals in Detroit will spread across the country. You can buy a nice big brick house in Detroit for $5000. The reason why is spreading to all general population areas of the USA. 

Edit: BTW I can buy a nice house here where I live for $5000 also. On the paradise island of Bali

Fri, 05/20/2011 - 07:46 | 1294930 jus_lite_reading
jus_lite_reading's picture

One hint we should never forget...

$.98. Lets see how many remember

Fri, 05/20/2011 - 02:08 | 1294743 TrueStrengthTur...
TrueStrengthTurnsTheCheek's picture

woah what a suprise evil bankers lying to us/manipulating data/buying time before SHTF and trying to keep normal people in the dark. and economists who try and use this kind of data to say the economy will be "okay"..smh. people say it the economy has cancer but it literally has brain cancer. we need to change how we see the world our whole mindset or were fucked. stop drinking so much flouride and it might be easier.

Fri, 05/20/2011 - 04:43 | 1294829 silberblick
silberblick's picture

Click below to watch YouTube's Harisebon7777777 short videos. He should be commended for his work on measuring the radiation levels in Tokyo. The device he uses costs about $1000, which I am sure he has paid out of his own pocket to provide us with the truth of what is really going on in Japan.

It is eerie to watch his videos. Typically, his hand is shown holding a geiger counter in some public place with people walking all around him as if there was nothing of importance going on; while all along, the geiger counter in his hand reveals what is really happening. Harisebon is documenting the slow irradiation of the Japanese archipelago. A visual unfolding of a tragedy.

While watching these videos. it is hard not to wonder how many of the folks one sees walking down the street will come down with cancer in 10, 20 or 30 years. In fact, the videographer's life itself is in peril. Poignant.

Go to Harisebon's YouTube channel and give him a shout-out. He deserves it.

http://fukushimadisaster.blogspot.com/2011/05/radiation-harajiku-omotesa...

Next, click below to read about the Orwellian steps taken by the Japanese government to hide from the foreign press (and its citizens) what is really going on in Fukushima:

http://fukushimadisaster.blogspot.com/2011/05/japanese-government-takes-...

Fri, 05/20/2011 - 04:46 | 1294837 AUD
AUD's picture

0.18 what? What's a dangerous level of radiation?

Fri, 05/20/2011 - 13:27 | 1296060 Hephasteus
Hephasteus's picture

That's almost safe if people weren't vacuum cleaners with the out with bad air in with the bad air. Out with the bad air in with the bad air.

Fri, 05/20/2011 - 05:05 | 1294840 Fíréan
Fíréan's picture

" . . . it has received zero attention outside of ZeroHedge "   ?

 

The good people at FT Alphaville have been covering this :

 

http://ftalphaville.ft.com/blog/2011/05/18/572156/all-hail-the-negative-...

Fri, 05/20/2011 - 06:11 | 1294856 emsolý
emsolý's picture

Anyone know what the implications on repo haircuts are for securities that are on "special"?

I.e. since there is high demand for them that warrants a negative repo rate, does demand also push the haircut much lower or possibly negative, as well? (that is, you get more cash than what the security is worth)

Fri, 05/20/2011 - 07:04 | 1294897 jm
jm's picture

In general, treasuries don't get haircuts when they go special.  Their behavior is essentially like being hard to borrow and you get short squeezes.   What happens to stocks in this case?  Short squeeze.  When government securities are short supply, you get accretion. 

What I think is funny is that PIMCO buys up the 20Y to keep it special.  The fed turned the tables and bought up every sector of the yeild curve to keep it special.  Needless to say, I think this has more to do with Bill Gross than many realize.

 

Fri, 05/20/2011 - 07:50 | 1294938 emsolý
emsolý's picture

Thx for your input. Interesting development, for sure.

Fri, 05/20/2011 - 06:03 | 1294861 aeiou260199038
aeiou260199038's picture

The apply contains alot more traditional roles these batterie kinds of as compounding and dispensing drugs...

Fri, 05/20/2011 - 07:28 | 1294911 tallen
tallen's picture

Davis, nicknamed ‘the Manhattan Madam’, said her records showed he first called her in January 2006 to request a fresh-faced ‘all-American’ girl, and paid $2,500 (£1,500) in cash for two hours with her in a hotel room.

But the girl came back complaining that he had been aggressive and she did not want to see him again.

http://www.dailymail.co.uk/news/article-1388748/Dominique-Strauss-Kahn-a...

 

Fri, 05/20/2011 - 08:08 | 1294964 Jack Sheet
Jack Sheet's picture

you think "GC-IOER" means "got caught - in and out of an extended rectum"

Fri, 05/20/2011 - 08:51 | 1295032 sharkbait
sharkbait's picture

What ever happed to good old 'fed funds'.  IOER?  There is a large element on Wall Street that have relaized their compensation level is entirely dependent on developing new acronyms to obfuscate stuff everyone already knows.

IOER, I'll stick with fed funds tank you very much.

Fri, 05/20/2011 - 11:39 | 1295579 mberry8870
mberry8870's picture

This is how it started in '07 & '08 with action rate securities locking up with really adverse implications to the money market world.

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