As Pummeling In GC-Reserve Carry Unwind Continues, All Carry Shifts To FX - Mrs Watanabe Wins After All

Tyler Durden's picture

Following our expose on the unwind in the repo (O/N GC) - reserve (IOER) carry trade yesterday, the FDIC induced compaction in the "free money" rate arb continues with GC sliding again to a jaw dropping 0.03%. And with this source of free money now shut down for good, and creating all sorts of havoc for short-term rates and further headaches for the Fed as it has one more black swan to deal with in extracting liquidity, all the free money trades have firmly shifted to FX carry, where the Yen is now the recipient of the wrath of every single Mrs Watanabe known to man. If and when Yen repatriation resumes in earnest (considering Japan GDP has to surge following its rebuilding effort as pundits claim), the outcome will be quite hilarious.


Carry basket, which following the surge in the Yen after the earthquake is now at the highest since May 2010!

And for those still confused by this developing dynamic, here is a quick note from BofA's Brian Smedley explaining again how the Fed is now completely cornered (even more than before).

Fed policy complicated by new FDIC regime

One of the main problems highlighted by the FDIC policy change is the unintended consequence that regulatory reform has on monetary policy. The new FDIC assessment regime, while intended to better protect taxpayers from large bank failures in the future, has distorted activity in the short-term rates markets through which the Fed traditionally implements monetary policy. In effect, the FDIC ruling change has to us created “easier” monetary policy and weakened the effect of IOER in sterilizing the excess liquidity created by the Fed’s expanded balance sheet. Unintended market consequences have thus far included some negative Treasury GC repo rate trading; specific Treasury issues trading at deeply negative rates in repo; an increase in failures to deliver certain repo collateral; and near-zero Treasury bill rates, which will likely be exacerbated in coming weeks by a seasonal decline in bill supply.

In another era, the Fed might have looked to counteract the impact of the FDIC change in the name of preserving market functioning and liquidity. But with markets hypersensitive to any signs that the Fed is about to take a turn toward the exit, could it tweak short term rates now without rates exploding higher, potentially causing expectations for the path of policy to become mispriced? After all, the fed effective remains well within the FOMC’s directive of 0-25bp.

Regardless of any near-term considerations, the Fed will need to offset this impact to regain control over short-term interest rates when it comes time to exit. Relative to the exit strategy it might have pursued in the absence of the new FDIC assessment regime, the Fed could eventually be required to drain a larger amount of excess reserves to regain control of the fed effective. Alternatively, and more likely in our view, the Fed could raise the IOER rate to a spread above the fed funds target. For instance, were the fed funds target be raised to 50bp, the Fed could raise IOER to 65bp or so. This would likely bring the fed effective closer in line with the fed funds target and would largely obviate the need for huge reserve drains.

But even this elegant solution is not without its complications: while the FOMC votes on the fed funds target, the IOER rate is determined solely by the Board of Governors. In our view, this could partly explain why some regional bank presidents, perhaps already disgruntled by the concentration of power at the Board throughout the crisis, have argued for a rapid normalization of the balance sheet and a return of the primacy of the fed funds rate in Fed  policymaking.

With the new FDIC regime now in effect and more regulatory changes on the horizon, we must put higher odds on the market becoming confused about the timing and impact of Fed policy in the future. For instance, could the Fed effectively communicate the difference between tightening policy and raising IOER to address potential disruptions in overnight markets? And how will the Fed regain control over short-term rates, which have become less closely  linked to IOER as a result of this change by the FDIC, when the time comes to exit? These questions could leave the economy exposed to more volatile inflation expectations at a time when the Fed needs the market to remain confident that it has both the willingness – and the appropriate tools – to achieve its mandate.

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Ferg .'s picture

Everyone is piling into FX carry trades . I'm looking at the charts for commodity dollars and I can barely believe my eyes . VERTICAL .

camaro68ss's picture

USD getting bitch slaped right now

falak pema's picture

what goes up fast, comes down hard next day! Just ask Benocide. He'll be willing to oblige.

Looks like the Euro will hit 144. JCT will have his work cut out tomorrow.

Ferg .'s picture

I'm think it'll finally hit the dust between 1.4400 and 1.4500 . Blow off top . Tomorrow is going to be volatile  !

Clueless Economist's picture

I propose a $4 trillion stimulus so we can create millions of shovel-ready jobs.  John Maynard Keynes is GOD

TruthInSunshine's picture

Paul, I have read (i.e. have been subjected to your tortured logic) some of your works.

You no doubt believe that we can eliminated the national debt by printing the matching number of FRNs, no?

Attitude_Check's picture

Not when they are borrowed into existence!  Now if they were directly printed without the underlying debt..... Of course the value would drop (to a more realistic value).

Yen Cross's picture

And the AUD is the benefactor of every free trade known known to Man and Woman. Greed!!!

SDRII's picture

2018 bonds bid 5.5x - sold to you

Ferg .'s picture

Fundamental analysis is dying everywhere . It's quite silly that AUD is still up at these levels , making record high after record high . Every logical support has deteriorated to some degree : rate hike expectations , economic data , the Chinese juggernaut etc...but of course now that the investment world has forgotten or no longer cares about the disasters in Japan , widespread revolution in the Middle-East , ongoing efforts by Chinese authorities to choke inflation , the relapse of the European periphery and a shit load of other stuff that could be categorized as ' risk negative ' , equities have given the one finger salute to logic and the bears and the AUD is moving in tandem , once again the darling high yielder of the FX world .  

Excuse me while I throw up in a bucket  .

Yen Cross's picture

Hey Technicals, Fundamentals, and Trend. All but the 2 most important are alive. Europe is going to hit a shitstorm alright. The Euro @ 143. ! I'm selling the news and the rumors over the next couple of weeks. I have done well, and some one else can fish for the last 20%.

Ferg .'s picture

Well looks we didn't get that blow off top I was expecting . Hope you got a decent price if you were selling ! ( short from 1.4310 myself ) .

Ferg .'s picture

A junk ? What part of my post warrants a junk ?

arnoldsimage's picture

i highly recommend your followers to read the book of luke chapter 21. we truly are running out of time.

sschu's picture

Luke chapter 21.

There are some real powerful messages here.

Without getting into a deep eschatology discussion, do you think Jesus was speaking about the 2nd destruction of the temple in 70AD or the end times?


arnoldsimage's picture

i believe he is referring to end times.

pvzh's picture

21:1  He looked up, and saw the rich people who were putting their gifts into the treasury.

Hmm.. "putting their gifts into the Treasury"... Looks like 401k/IRA will be "confiscated", i.e. all assets in them will be swapped for treasuries.

Abitdodgie's picture

Like all readings in the bible it is very ambiguous and could be con scribed to mean anything, also in the old testament have you ever tried to add up how many people God killed ,I gave up after everyone on the planet except Noah and his family ,it is not very all as one loving is it , more up there with pol pot or Hitler , or Genghis Khan

arnoldsimage's picture

perhaps you should read Job.

falak pema's picture

I recommend swimming off the Fukushima water front for all those who believe that war is the only solution to our problems...anywhere, any time, any how; Just war more war. Go take a swim in Fukushima mon amour. 

Canucklehead's picture

Falak, you are missing the point.  Since time immemorial, you tack into the wind while navigating troubled waters.  If war comes calling, you answer... or submit.  It is a zero-sum decision.  Nobody really wins.  The victor loses less.

Now you can attempt to place yourself in a seat of judgement and pontificate.  That does not always end well.  It may buy you some time.  You may find "friends" who will protect you, for a price.

Bold Eagle's picture

Was yen intervention really necessary? Rhetoric question, I know.

Yen Cross's picture

Everyone runs for a target. No it wasn't. Didn't you see the spike down 2 weeks ago.

flustercuck's picture

i have a bridge to repo out... anyone want to take the other side?

TruthInSunshine's picture

Bernanke is running out of time.

In fact, he's out of time.

There's not going to be any easy coordination or implicit co-operation on currency policy given the events in Japan, China and the Eurozone, and if anyone here thinks that Bernanke won't be made a sacrificial lamb by the ever calculating Team Obama, should the trends enraging and dispiriting Americans continue much longer, as Obama attempts to reclaim office, well, you just haven't been paying attention to what a fresh coat of paint can do for a rusty pig.

Besides, Axlerod and Plough's calculus will be that Independents want more austerity and more hawkish monetary policy (less inflation on food, energy and other things of necessity), and that Obama needs to retain at least a significant chunk of independents in order to win re-election, so it's a matter of when and not if.

For those who watched Steinhardt's dressing down of ObamaNomics on CNBC with Joe 'SmugFace' Kiernan and Becky 'knobgoblin' Quick, you couldn't have missed the reference to retirees getting tossed under the bus due to ZIRP, nor his remarks that the average American living outside of Manhattan or D.C. has been forgotten about.

So it will be Obama for King Dollar sometime in late 2011 or early 2012, because politics is all about the when.

You heard it hear first!

JLee2027's picture

Sounds like the Fed is losing control.

SheepDog-One's picture

Lets see, before the quakes, tsuniamis, and reactor melt downs Japan was totaly bankrupt as a nation. However now theyve suddenly got complete rebuild and GDP recovery priced in? Utter nonsense.

topcallingtroll's picture

Sounds like everyone is a buy the dip contrarian now. How to pivot ahead of the crowd these next few months is the issue. I say sell in may and go away.....risk off will be the new risk on.

Yen Cross's picture

The Fed is not even remotely close to being able to direct monetary policy. They are still stuck in damage control mode.

SheepDog-One's picture

The FED is just living day to day now, damage control best as possible today to live to damage control another day.

alexanderstollznow's picture

i am guessing that Shiela Bair doesnt get a lot of dinner invitations to the Bernanke household....

topcallingtroll's picture

I bet a lot of people miss ur subtle humor at times!

We financial junkies know what bored japanese housewives do when they think no one is looking.

Who would have thought a guy might get bored with a small harem so quickly? but i have learned that man does not live by pussy alone, but by every word from the mouth of tyler.

Irwin Fletcher's picture

Is this the first post-tsunami japanese housewife joke? Glad to see ZH returning to some semblance of 'normalcy', whatever that means in today's world. It didn't take the Japanese BitTorrent crowd long:

simon says's picture

Banks to Fed - Pay Us More On Reserves ... Or Else.