Repo Market

Previously we explained on at least two occasions (here and here) why the upcoming death of the US money market industry is not greatly exaggerated: quite simply, as we wrote back in 2010, the Group of 30, or the shadow group that truly runs the world (see latest members) decided some time ago that it would rather take the "inert" $2.6 trillion held in money markets, and not used to boost the fractional reserve multiplier, and instead have it allocated to such more interesting markets as bonds and stocks. As a reminder, Europe already achieved this last month when it cut its deposit rate to zero leading to a sequential shuttering of money market funds. The Fed, however, has to be far more careful to not impair the overnight General Collateral repo market which as everyone who understands the nuances of Shadow Banking knows is where all the bodies are buried, and as such has been far more careful in implementing such a shotgun approach. Instead, Ben, the SEC, and the Group of 30 have adopted a far more surgical approach to destroying money markets: they want investors themselves to pull their money by implementing such terminally destructive measures as floating NAV, redemption restrictions and capital requirements, which will achieve one thing - get the end user to pull their money from MM and put the cash either into either deposits, where it can then proceed to be "fractionally reserved" into the banking system, or to boost AMZN's 250+ P/E. After all the number under observation is not modest: at $2.6 trillion, this is almost 20% of the market cap of the US stock market. So it was only a matter of time before major money market institutions, in this case Federated first, but soon everyone else, starts screaming and warning that money markets are about to die (which they are). 

As Messers Frank and Paul take on the Bernank this morning, we reflect on the four easing options that the illustrious fed-head laid out in a statement-of-the-obvious that still managed to get the algos ripping. As Goldman notes, his prepared remarks were terse (and lacking in 'easing options' discussion) - cautious on his outlook, concerned at Europe, and fearful of the 'fiscal cliff' - but his response in the Q&A were a little more revealing as he laid out his choices: asset purchases, discount window lending programs, changes in communication about the likely path of rates or the Fed balance sheet, or a cut in the interest rate on excess reserves. We discuss each below but note, just as Goldman believes, that while we think that a modest easing step is a strong possibility at the August or September meeting, we suspect that a large move is more likely to come after the election or in early 2013 (and not before), barring a very rapid further deterioration in the already-cautious near term Fed economic outlook (which we assume implicitly brings the threat of deflation).

There is a saying that it is better to remain silent and be thought a fool than to speak out and remove all doubt. Today, the San Fran Fed's John Williams, and by proxy the Federal Reserve in general, spoke out, and once again removed all doubt that they have no idea how modern money and inflation interact. In a speech titled, appropriately enough, "Monetary Policy, Money, and Inflation", essentially made the case that this time is different and that no matter how much printing the Fed engages in, there will be no inflation. To wit: "In a world where the Fed pays interest on bank reserves, traditional theories that tell of a mechanical link between reserves, money supply, and, ultimately, inflation are no longer valid. Over the past four years, the Federal Reserve has more than tripled the monetary base, a key determinant of money supply. Some commentators have sounded an alarm that this massive expansion of the monetary base will inexorably lead to high inflation, à la Friedman.Despite these dire predictions, inflation in the United States has been the dog that didn’t bark." He then proceeds to add some pretty (if completely irrelevant) charts of the money multipliers which as we all know have plummeted and concludes by saying "Recent developments make a compelling case that traditional textbook views of the connections between monetary policy, money, and inflation are outdated and need to be revised." And actually, he is correct: the way most people approach monetary policy is 100% wrong. The problem is that the Fed is the biggest culprit, and while others merely conceive of gibberish in the form of three letter economic theories, which usually has the words Modern, or Revised (and why note Super or Turbo), to make them sound more credible, they ultimately harm nobody. The Fed's power to impair, however, is endless, and as such it bears analyzing just how and why the Fed is absolutely wrong.

With Operation Twist being extended for another 6 months, forcing Primary Dealers to buy up all the short-end bonds from the Fed, the last thing the Dealer community needed at today's 2 Year bond auction was to be stuck holding the bag. Which is precisely what happened: the Treasury sold $35 billion in fresh 2 year paper as the first auction of this week's trio of bond issuance, at a yield of 0.313%, the highest since March even if in line with the When Issued, and a Bid To Cover of 3.62, the lowest since February. But the key internal indicator was the distribution between the Primary Dealer take down and everyone else: at 60.4% of the entire offering or $21 billion, going to Dealers, this was the highest notional having to be stuffed in the channels of the Primary Dealer repo market since December 2011. Naturally, the offset, Direct and Indirect takedown, was quite low, with Indirect bidders holding just 31.69% of the auction, or the lowest since December as well. Unless the PDs can offload the bonds quickly and effectively, this means they are stuck with another product for $21 billion which will generate returns far lower than ROI and ROE breakevens, and force them to take even more risks with whatever other capital they have lying around courtesy of US depositors.

As Predicted Last Year, The French and the Greeks Are In A Race For The Biggest Bank Run! Each stock showcased has led the drop as well...

It may not be quite the 0% coupon which Germany got yesterday for its 2 year bonds (soon realistically going negative if the demand is there), but lending $35 billion to Uncle Sam at a cash interest of 0.625% and a record low yield of 0.748% is still quite remarkable. Because with this auction, total US debt/GDP is now almost 103% (rounded up). But who cares: when one needs to parks cash in a hurry, one will do just what the herd is doing, consequences of groupthink be damned. The internals: 2.99 Bid To Cover, higher than the TTM average of 2.924%, but of note was the slide in Indirect Bidders which bought "only" 42.6% of the auction, and Directs, who only purchased 6.5% of the total. This means that for the first since June 2011, Primary Dealers, who promptly take the proceeds and flip it for cash into the limbo that is the custodial repo market, amounted to over half of the total takedown, or 50.9%: hardly a ringing endorsement when one strips away the ponzi apparatus that is the PD bid. That said: Uncle Sam will take it, and will certainly take another $29 billion in 7 year bonds tomorrow, which will also likely price at an all time low yield.

Name the plunging bond shown on the left. If you said some sovereign or corporate issue based out of Spain, Italy, Ireland, Portugal, or even Greece you would be close... but no cigar. No - the bond in question is an issue of Caisse Centrale du Credit Immobilier de France (3CIF), which together with its sister entity CIF Euromortgage (CIFE), is  a 100% subsidiary of Credit Immobilier de France Development (CIFD), which as Fitch describes it, is a French "housing loans specialist, with business exclusively directed to France." CIFD is in turn owned by Procivis Group, which just happens to be France's second largest full-service real estate group.

We are in the last innings of a very bad ball game. We are coping with the crash of a 30-year–long debt super-cycle and the aftermath of an unsustainable bubble. Quantitative easing is making it worse by facilitating more public-sector borrowing and preventing debt liquidation in the private sector—both erroneous steps in my view. The federal government is not getting its financial house in order. We are on the edge of a crisis in the bond markets. It has already happened in Europe and will be coming to our neighborhood soon. The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. Capital markets are at the heart of capitalism and they are not working.

If the greatest trick the devil ever pulled was convincing the world he didn’t exist, the greatest trick our central bank ever pulled was convincing the world we couldn’t live without it. For most of that past twenty years, that PR campaign has been centered on the Great “Moderation”, so called because it apparently represented the full embodiment of economic management – a period of unparalleled prosperity, a Golden Age of soft economic central planning. Give the central bank enough “flexibility” and it will produce unmatched economic and financial satisfaction.

When we last discussed what now appears certain to be a TBAC announcement tomorrow that Floating Rate Treasurys are about to be launched by the US during the Treasury, we cautioned, using an analysis by the IMF's Singh, that "the US Treasury may be telegraphing to the world that it, or far more importantly, the TBAC, is quietly preparing for a surge in interest rates." We then continued that "What is also obvious is that if the TBAC is quietly shifting the market into preparation mode for "a steady (or rocky) rise in rates from near zero to a "neutral" fed funds rate of 400 bps and a "normal" 5 percent yield on 2 year U.S. Treasuries" as the IMF warns, then all hell is about to break loose in stocks, as by now everyone is aware that without the Fed liquidity, and not just liquidity, but "flow" or constant injection of liquidity, as opposed to merely "stock", VIX will explode, equities will implode, and all hell would break loose. It is not yet certain if the TBAC will proceed with implementing FRNs. Although, since the proposal came from the TBAC, read Goldman and JPM, and what Goldman and JPM want, they get, it is almost certain that in about a month, concurrent with the next quarterly refunding, America will slowly but surely proceed with adopting Floaters." Judging by the amount of press coverage this topic has received in the past week, the advent of FRNs is now a given. What is unclear is why: our take is that this is simply a move to make Treasurys more palatable to investors, simply to avoid capital losses when rates finally resume their inevitable surge higher. The flipside of course, is that the guaranteed coupon payments in a rising rate environment means that more cash will leave the Treasury to cover interest. It is this corollary to increasing demand that has made the "father" of Treasury floaters warn on Bloomberg that now is the worst possible time to being sales of FRN Treasurys.

Addressing his perception of lessons learned from the financial crisis, Ben Bernanke is speaking this afternoon on poor risk management and shadow banking vulnerabilities - all of which remain obviously as we continue to draw attention to. However, more worrisome for the junkies is the total lack of QE3 chatter in his speech. While he does note the words 'collateral' and 'repo' the proximity of the words 'Shadow, Institutions, & Vulnerabilities' are awkwardly close.

While Europe is once again back on the radar, having recently disappeared therefrom following the uneventful Greek CDS auction (which in itself was never an issue - the bigger question is any funding shortfall to fund non variation margined payments, as well as the cash to make whole UK and Swiss law bonds) following Buiter's earlier announcement that Spain is now in greater risk of default than ever, coupled with Geithner and Bernanke discussing how Europe is 'fine' in real time, here are three quick charts which will remind everyone that nothing in Europe has been fixed. In fact, it is now worse than ever. As a reminder, when thinking of Europe, the shorthand rule is: assets. And specifically, the lack thereof. Why is the ECB scrambling to collateralize every imaginable piece of trash that European banks can procure at only some valuation it knows about? Simple - quality, encumbrance and scarcity. When one understands that the heart of Europe's problem is the rapid "vaporization" of all money good assets, everything falls into place: from the ECB's response, to Europe's propensity for infinite rehypothecation, to the rapidly deteriorating financial system. It also explains why America will be increasingly on the hook, either via the Fed indirectly (via FX swaps), or indirectly via the IMF (such as two days ago when US taxpayers for the first time funded the first bailout check to the ECB using Greece as an intermediary).

Little to note about today's unremarkable bond auction of $35 billion in 5 Year bonds. Hot on the heels of yesterday's just as unremarkable  2 year bond auction, which saw total US debt/GDP surpass 101% two weeks after total debt/GDP rose over 100% for the first time, the details surrounding today's issuance were more or less as expected: the closing yield of 0.90% was inside the When Issued of 0.905%. The Bid To Cover was 2.89, weaker than January's 3.17, but right inline with the TMM BTC of 2.89. The Indirects took down 41.8%, Directs 12.9%, and the Dealers held at 45.3%, all in line with TTM average, so nothing to write home about. Overall an auction that just added a few pips to the total US debt/GDP, with the proceeds, especially by the Dealers, promptly to be pledged back into the repo market with the blessings of BoNY and State Street, where it is never heard from again.

Today, without much fanfare, US debt to GDP hit 101% with the latest issuance of $32 billion in 2 Year Bonds. If the moment when this ratio went from double to triple digits is still fresh in readers minds, is because it is: total debt hit and surpassed the most recently revised Q4 GDP on January 30, or just three weeks ago. Said otherwise, it has taken the US 21 days to add a full percentage point to this most critical of debt sustainability ratios: but fear not, with just under $1 trillion in new debt issuance on deck in the next 9 months, we will be at 110% in no time. Still, this trend made us curious to see who has been buying (and selling) US debt over the past year. The results are somewhat surprising. As the chart below, which highlights some of the biggest and most notable holders of US paper, shows, in the period December 31, 2010 to December 31, 2011, there have been two very distinct shifts: those who are going all in on the ponzi, and those who are gradually shifting away from the greenback, and just as quietly, and without much fanfare of their own, reinvesting their trade surplus in something distinctly other than US paper. The latter two: China and Russia, as we have noted in the past. Yet these are more than offset by... well, we'll let the readers look at the chart and figure out it.

In a late, and somewhat underplayed, story from the WSJ, it appears that we may finally get some answers on exactly what former-Treasury-Secretary-to-be Geithner knew and sanctioned in the lead up to the Lehman fail. More specifically how JPMorgan illegally siphoned billions of dollars from Lehman in the final days, potentially via Geithner's FRBNY-overseen tri-party repo market. We discussed this at length almost two years ago as the FRBNY was concerned at the ongoing risk of the market being structurally vulnerable to a repo run and furthermore why Lehman's suit against JPMorgan had grounds. Critically, with Geithner being the man at the helm of the entity that approved repo entry and exit and in the final stages clearly sided with JP Morgan as collateral calls rained down, it makes sense to at least find out what he knew and decided - under oath.