A month ago we showed the chart that we suspect scared Bernanke straight [8] and required his verbal intervention to de-froth the US Treasury market. The huge surge in 'fails-to-deliver' in the US Treasury market meant something was very wrong as this critical indicator of both collateral shortages and technical carry trade unwinds was flashing a very angry red (and as Barclays notes "was ready to feed upon itself"). Bernanke's jawboning provided just the right amount of concern at the Taper that the market began to clear a little and 'fails' have been reduced (though we note are rising once again as un-Taper exuberance returns). The problem is - exactly the same critical dilemma is now hitting the JGB market and as JPMorgan warns, the sharp rise in fails in June suggests that there is perhaps more stress in the JGB market than that conveyed by the recent stability of JGB yields.
Treasury Fails surged and Bernanke was scared 'straight'... but now the un-Taper talk is back, the fails are resurging...
[9]
Simply put, the main reason the Fed will taper has nothing to do with the economy and everything to do with the TBAC presentation (rehypothecation and collateral shortages) [10] and that the US is now running smaller deficits!!!
Via JPMorgan,
We showed before, the rise in repo fails in April in response to the rise in JGB volatility at the time. These reverberations continued in June with further sharp rise in fails (Figure 5). 233 repo fails in the month of June is four times larger than the typical monthly pace of 60-70. It is still much lower than the >1000 number of fails seen immediately post-Lehman.
[11]
A fail is a situation where a recipient of JGBs in a transaction does not receive the JGBs from the delivering party on the scheduled settlement date. It is not common to see such a persistent rise in fails in the JGB market. Typically the number of fails in Japan is quite small, partly because market participants try to avoid fails in advance, and because some market participants have never experienced fails. According to the BoJ, the situation is quite different from that prevailing in US repo markets, where fails occur much more frequently than in Japan and where market participants take action in accordance with the fails practice on a daily basis. Market participants are comfortable or accustomed to controlling risks through margin calls without often setting a haircut upfront.
But these margin calls or haircuts where applicable, tend to rise in periods of stress with a resulting increase in fails. The sharp rise in fails in June suggests that there is perhaps more stress in the JGB market than that conveyed by the recent stability of JGB yields.
So - just as Bernanke was forced to back-pedal (albeit briefly) on his unlimited omnipotence due to the broken UST market, will Kuroda have to jawbone back frothy expectations amid a collateral shortage in the JGB market?
Source: JPMorgan and NY Fed [12]