BIS Warns The Fed Rate Hike May Unleash The Biggest Dollar Margin Call In History

Tyler Durden's picture

Over the past several months, one of the biggest conundrums stumping the financial community has been the record negative swap spread which we profiled first in September,  and which as Goldman most recently concluded, "has been driven by funding and balance sheet strains, especially since August."


Today, in its latest quarterly report, the Bank of International Settlement focused precisely on this latest market dislocation.  According to the central banks' central bank, "recent quarters have witnessed unusual price relationships in fixed income markets. US dollar swap spreads (ie the difference between the rate on the fixed leg of a swap and the corresponding Treasury yield) have turned negative, moving in the opposite direction from euro swap spreads (Graph A, left-hand panel)."

Given that counterparties in derivatives markets, typically banks, are less creditworthy than the government, swap rates are normally higher than Treasury yields because of the additional risk premium. Hence, the negative spreads point to a possible dislocation. One set of factors relates to supply and demand conditions in interest rate swap and Treasury bond markets. In the swap markets, forces that can compress swap rates include credit enhancements in swaps, hedging demand from corporate bond issuers, and investors seeking to lock in longer durations (eg insurers and pension funds) by securing fixed rates via swaps.


In cash markets, in turn, upward pressures on yields stemmed from the recent sales of US Treasury securities by EME reserve managers. The market impact of these Treasury bond sales may have been amplified by a second set of factors that curb arbitrage and impede smooth market functioning. First, the capacity of dealers’ balance sheets to absorb rising inventory may have been overwhelmed by the amount of US Treasury bonds reaching the secondary market in the third quarter (Graph A, centre panel), causing dealers to bid market yields above the corresponding swap rates. Second, balance sheet constraints may have made it more costly for intermediaries to engage in the speculative arbitrage needed to restore a positive swap spread. Such arbitrage is sensitive to balance sheet costs because it requires leverage, with a long Treasury position funded in the repo market.

Meanwhile, while US swap spreads hit record negative levels, in Europe the market tensions have been of a different nature:

Ten-year swap spreads started to widen in early 2015, around the time when the Swiss National Bank abandoned its currency peg, then increased further over subsequent months (Graph A, left-hand panel). While past episodes of widening swap spreads can be attributed to credit risk in the banking sector, the most recent developments may have more to do with hedging by institutional investors. While swap rates also fell (Graph A, right-hand panel), the swap spread widened, indicating that cash market yields fell by even more. One possible explanation is that, as yields fall amid expectations of ECB asset  purchases, institutional investors with long-duration liabilities, such as insurers and pension funds, would have been under pressure to extend their asset portfolio duration by purchasing additional longer-dated bonds, possibly compressing market yields below the swap rates.

And with cash markets rapidly depleting of physical inventory as a result of central bank monetization, investors have had to rely on derivatives markets, especially swaptions.

In addition to extending portfolio duration by purchasing longer-dated bonds or entering a long-term interest rate swap as a fixed rate receiver, investors may also hedge the risk of steeply falling yields by purchasing options to enter a swap contract at a future date (swaptions). Hence, swaptions tend to become more expensive in times of stress and when investors rush to hedge duration risk.


As 10-year swap rates were compressed in early 2015, the cost of such options written on euro swap rates rose by a factor of three by 20 April 2015 (Graph B, left-hand panel). Steeply rising euro rate hedging costs preceded the actual correction in yields, which started rebounding around the weekend of 18 April culminating in the so-called bund tantrum. This suggests that this year’s turbulence in fixed income markets may have had its origins in derivatives and hedging activity, with reduced market depth in cash markets exacerbating the spillover.

Why is there reduced market depth in cash markets? Simple: because of central banks intervention and soaking up of securities. So what the BIS is effectively saying is that as a result of central bank activity, investors have been forced to transact increasingly in the derivative arena as a result of which events like the Bund flash smash from April led to major market losses for those long Bund duration in either cash or derivative markets. Since then, volatility in European government bond markets has persisted culminating with the surge in yields this past Thursday in the aftermath of the ECB's dramatic and extensively discussed here previously "disappointment."

The BIS' conclusion:

Such volatile movements in euro area interest rate derivatives markets raise questions about smooth pricing responses in the face of possibly transient order imbalances. Of question is liquidity in hedging markets and the capacity of traditional options writers, such as banks, to provide adequate counterparty services to institutional hedgers. Looking back at the events of late April, the rise in demand to receive fixed rate payments via swaps by institutional hedgers may have run into a lack of counterparties willing to receive floating (pay fixed) rates amid sharply falling market yields. The emergence of one-sided hedging demand pressures can be gleaned from the skew in swaption pricing (Graph B, centre and right-hand panels). The skew observed for euro rates approaching the bund tantrum resembled the developments in US dollar rates in December 2008, when US pension funds rushed to hedge interest rate risk via swaptions as market yields tumbled.

But while the swap dislocation in the bond market can be attributed to anything from market illiquidity, to a shortage of cash market product, to lack of willing counterparties, to HFTs, and ultimately, to encroaching central bank intervention - something we have been warnings about since 2012 - perhaps an even more important question to emerge when observing broken swap markets are recent development in FX basis swaps.

Recall our coverage of one particular and very prominent dislocation in the space, one which we covered first in March and then again in October when we noted that the "Global Dollar Funding Shortage Intesifies To Worst Level Since 2012".

This is how JPM explained most recently the phenomenon which can simply be ascribed to a global dollar funding shortage:

"continued monetary policy divergence between the US and the rest of the world as well as retrenchment of EM corporates from dollar funding markets are sustaining an imbalance in funding markets making it likely that the current episode of dollar funding shortage will persist."

The BIS also touched on this topic in its quarterly review, when it picked up the "policy divergence" torch from JPM and describing the ongoing USD funding shortage as follows:

The increased likelihood of policy divergence between the US, the euro area and other major currency areas also rippled through global US dollar funding markets. Historically, cross-currency basis swap spreads – a measure of tensions in global funding markets – were virtually zero, consistent with the absence of arbitrage opportunities. Since 2008, the basis has widened repeatedly in favour of the US dollar lender, ie there is a higher cost for borrowing in dollars than in other currencies even after hedging the corresponding foreign exchange risk – conventionally recorded on a negative basis (Graph 5, left-hand panel). As such, negative basis swap spreads indicate the absence of arbitrageurs to meet heightened demand for US dollar liquidity.


To be sure, our readers were aware of this implication of diverging monetary policy. However, thanks to the BIS, we now can add a quantitative dimension to what until recently what mostly a qualitative problem: i.e., how much is the dollar shortage as implied by the near record negative USDJPY currency basis swap spreads.

The US dollar premium in FX swap markets widened substantially – in particular vis-à-vis the Japanese yen – after the odds of Fed tightening reached 70%. At the end of November, the basis swap spread of the Japanese yen versus the US dollar was minus 90 basis points, possibly reflecting in part the more than $300 billion US dollar funding gap at Japanese banks.

The BIS does its best not to sound the alarm at this stunning observation:

While funding continued to be available, such a large negative basis indicates potential market dislocations. And this may call into question how smoothly US dollar funding conditions will adjust in the event of an increase in US onshore interest rates. Similar pricing anomalies have also emerged in interest rate swap markets recently, raising related concerns.

Indeed, once the Fed does hike rates as it now seems almost certain it will do in 10 days time, we will find out just how profound the USD funding shortage truly is. Readers may recall that in 2009 we cited a BIS report which said that "were all liabilities to non-banks treated as short-term funding, the upper-bound estimate [of the dollar short] would be $6.5 trillion".


This time around, as a result of the dramatic increase in USD-funded debt around the globe in the past 5 years, it will certainly be far greater.

And, as a further reminder, the last time a global USD margin call was launched with the failure of Lehman, the Fed had to unleash an unprecedented global bailout by way of virtually limitless swap lines opened with every central bank that has a shortfall in USD exposure.


As a result, our only question for the upcoming Fed rate hike is how long it will take before the Fed, shortly after increasing rates by a modest 25 bps to "prove" to itself if not so much anyone else that the US economy is fine, will be forced to mainline trillions of dollars around the globe via swap lines for the second time in a row as the world experiences the biggest USD margin call in history.

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I poop on paper,

And au contraire,

Silver is the suit I wear,

US dollar isn't even there.

HedgeAccordingly's picture

Its coming... tick tock tick tock.. 

Reverse the chart.. instead of fracture to downside, fracture to upside..

FLASH CRASH via US Dollar Index.. The Next Chernobyl?
malek's picture

Finally, Yellen's first excuse for not hiking has arrived on the scene!

bigkahuna's picture

FEDs not hiking anything.

Macchendra's picture

BIS is saying this to weaken the dollar before a planned short.

GrowerJohn's picture

I think Bitcoins will hit a price of $100,000 each long before the Fed hikes the interest rate!

Dr. Spin's picture

*** OFF TOPIC ***

We gladly feast on those who would subdue us. 

The first black president:  William Jefferson Clinton
The first woman president:  Barack Hussein Obama

Bwahahaha, urp, urk, koff, koff

Just finished watching "Zeitgeist".  WOW!  This is a fine explication of the current state of affairs...

Topics covered:  Religion, War, Money, Social Manipulation.

This could be the "wake up" tool you've been looking for...

Spoctor Din

Dr. Spin's picture

You know, it's pretty lazy and chickenshit to downvote a post and not say why.  How many of you naysayers have actually seen the movie and can pan it intelligently???

Spoctor Din

Beowulf55's picture

your only 6 years behind the curve..............welcome to the real world..............

Dr. Spin's picture

Just dredging tools to help wake the sheeple up...


Papi_Al-Mahdi's picture

The piece on Christianity in that doc is malarky and it threatens to take away from the other 2 sections that actually are quite good. I think there are better documentaries to refer people to.

The Arrivals - if you can find this, it is amazing. It's taken down often, but a current link is

America Freedom to Facism

The books - The Creature from Jekyll Island, Confessions of an Economic Hitman, Hegemony or Survival.


OutaTime43's picture

I heard Dutch Tulips were better than cash. You should check it out.

fockewulf190's picture

Is there an ETF for them?  I don´t want the biological, just the paper equivalent.

bookofenoch's picture

Snorted egg nog through my nose on this comment!

WhackoWarner's picture

USD will soar,  Then Chernobyl, Ushered in by many coordinated false flags that distract.  USD will soar as it is now.  Anyone here believe USD is backed by anything?  So why soaring last week?  this game, this game. And this game is analysed like somehow evil and greed could be charted.


Flash crash?  Maybe in time but not right now.  This game, this game.   I think the perps need to really think about hiding.  Sooner than later more people will start to connect the dots.  IF NOT we are lost. Kiss the earth goodbye.


It is the senseless deaths of so many that are going to be lost in the prelude.



sun tzu's picture

The stock market is like Wiley Coyote. Don't look down.

WhackoWarner's picture

In many ways part of every world problem at the moment is the inability of US (God=given super yahoo) to see beyond their own ego.   I Write Code I suspect you are US born and bred.


Bring it on is the USA propaganda.

Quinvarius's picture

They still can't come to grips with the fact the Fed and Treasury are taking the USD lower.  Nothing will change that. The USD didn't do anything in 2009.  It won't do anything now.  You'll be able to get all the cheaper dollars you want in a few months.  I am not a GS retard calling for some instant apocalyptic tail event.  I am just saying, they are taking it lower.  The USD is incredibly over priced.  It is wrecking the economy.

DontWorry's picture

Help me out - how will raising rates take the dollar lower?

two hoots's picture

Better than that, tell me what that article even said ?   Reminds me of the old saying:  "what's that got to do with the price eggs?"

Slarti Bartfast's picture

It means the price of USD will spike up in terms of other currencies.

Another reason to buy some USD for the short term.

Tall Tom's picture

It means massive Bank Failures and a Global Credit Freeze due to a lack of liquidity.


There is not enough US Dollars in existence to bail it out this time.


Last time they had toshit out $6.5 Trillion to stabilize the Global Banking System.


There is no political will here in the USA to do it again.


Raise those rates Yellen...Pleeeeeeeeze


It is just a thin wafer...a very thin wafer.

TheFutureReset's picture

The same way the last card on a castle causes it to tumble. We don't know exactly which card, but keep putting them on and it's going to happen. The interest rate hike is a gigantic oversized card.

Tall Tom's picture

It is stable. It is only a small snowflake.


It is just a very small snowflake compared to all of that snow...


Raise those rates Yellen...Pleeeeeeeeeze?.

WhackoWarner's picture

WHAT DELUSION do you retain that allows that the completely immoral FED has your interest at heart? PLEASE AMUSE YOURSELF AND PLOT A CHART.  Ever plotted a psychopathic's logic?  Wish you luck.

Nexus789's picture

The only dice left for the fed to roll is to protect the Dollar to continue the empire. Everything and everyone else is disposable.

order66's picture

And outside of this nightmare, this is what global finance currently looks like:

Unix's picture
Unix (not verified) Dec 6, 2015 5:43 PM

It will never be raised, about armageddon bwahahahaarg

Montani Semper Liberi's picture

  But, but the markets have the fed rate hike already priced in, right?

 What difference does it make anyway? The DAX will probably have a nice bump tomorrow morning, plus gold and silver will be smacked down for having the audacity to gain 2% last Friday. Some pissed off paper shorts out there will rule the day.

 Same as it ever was.

Crabshacker's picture

Never going to happen while Bathhouse Barry's in office..

Unix's picture

wont matter who's in da house, never gonna happen now...

WonderDawg's picture

It makes not one fucking bit of difference who is in office. This has absolutely nothing to do with politics, this is about maintaining the global financial system.

Barrack Chavez's picture

--> "Never going to happen while Bathhouse Barry's in office.."

Oooohhh.. Maybe the fascist Nobel peace prize winner will draw a red line across the sand in Syria..

Or will he blame a YouTube video for starting riots outside the Fed/ECB headquarters?

Obama: "If you like your current health insurance, you can shove it..."

falak pema's picture

The currency wars pit China against weakest head of three headed Cerberus : The euro !

lasvegaspersona's picture

There is wide spread failure to understand how the structure of the Euro will allow it to survive while all other currencies fail.

Let me explain. Most here understand that gold is still the underlying asset that provides currency with legitimacy. Almost every currency on the planet uses treasuries to perform this function now. The US would like to keep it that way but for the past 44 years the US has been printing way more than it should and until recently the central banks of the world helped the US by using the excess dollars they acquired through trade to buy treasuries and they kept those dollars on their balance sheet. In a sensible world most of those dollars would have been sent back to the US to buy goods and services. The monetary system we have at present encourages this insanity.

The Euro did something different. It used gold in addition to treasuries as a primary asset on the ECB balance sheet. Not only that but instead of holding gold at a fixed price, as it was done under the gold standard, the ECB marks its 10,800 tons of gold to market. When we finally see the dollar drop and the price of gold rise, the balance sheet of the ECB will rise as all the others fail. 

In the end every other country will have to redesign their currencies to be like the Euro. The use of gold in this way allows gold to function as treasuries do now. Countries can intervene in the Forex markets to stabilize their currencies if they wish and they can use gold to do this. At present the US has no gold on the balance sheet of the Fed. Most other countries do not either. Most nations that buy gold do it for their treasuries and not for their central banks. If the dollar fails the Fed will not have to surrender any gold. (It might to defend the dollar in a panic but the 8134 tons on the treasury's book will be safe. It can be used to structure a new currency, the 'New Dollar, if you will.

The same process will happen to all other major currencies. They will eventually become mere medium of exchange and used mostly for local sales. Internationally gold will be used for settlement by nations and for saving by individuals.

This is very difficult to see in a world in which all monetary thoughts are in dollars. When the dollar finally goes though, many will wonder why they did not see this coming. By many I mean all of us and all the gold experts (Fofoa excepted).

What sounds insane today will make sense later. I'm amazed that so many understand the value of gold and the frailty of the dollar but they can't see this.

bookofenoch's picture

Ok. You're on.

Meet me here in 2018 and let's see if the Euro shit the bed.

Barrack Chavez's picture

Let me explain how smart I am sitting in my academic chair, and how dumb all you people out in the real world are...

Its like listening to the lecture/speech from Peter Pan...

Not My Real Name's picture

FOFOA: The euro is doomed whether the EU marks its gold to market or not. It's a political problem; you can't have a single currency representing the disparate cultures and interests of all the countries in the Euro Zone. It is untenable.

Womb Service's picture

Not to mention the goofy idea that they actually have real Gold backing it. As the world crashes those vaults will be mysteriously empty. Paper is paper is paper...

Tall Tom's picture

How much Eurogold has been rehypothecated?


How much German Gold "held" in American Banks has Germany pledged to the Euro?


How much actual Physical Gold does the ECB actually possess in Physical form and not pledged out, leased out, rehypothecated, Doctor?


My bet is that there is not 10,800 MT in their vaults as there is not 8134 MT in the USA vaults.


There has been a Gold Heist Doctor....the largest Gold Heist in History. It has happened right in front of you.

PoasterToaster's picture
PoasterToaster (not verified) Dec 6, 2015 5:22 PM

Couldn't happen to a nicer group of assholes.

Johnny Horscaulk's picture
Johnny Horscaulk (not verified) Dec 6, 2015 5:23 PM

in other words there's way too much debt and the us dollar has clay feet... but the banks want to keep the wealth transfer from workers to banks going on as long as possible.

pain now or more pain later.

ms8173's picture

Will this make the USD go up or down?

Unix's picture


Salah's picture

"margin call" ?? ZH--simplify this shit.

with an $11 TRILLION  dollar cary's more than a 'margin call'

"It's What's for Dinner"  (why one has a 'big stick' to begin with)

WhackoWarner's picture

USD wll go up to shine as the beacon of fools. 


There are way too many people across this planet who are simply wishing for a way to save the (excess profits) product of  labour in a stable venue.


The gambling, entitled psychopaths could not dig their own graves (they'd employ someone).   


IF there is synchronicity to our lives