Repo Market

It was a tale of two markets overnight: Asia first - where all commodity hell broke loose - and then Europe (and the US), where central banks did everything they could to stabilize the already terrible sentiment.

After yesterday's unexpectedly strong 2 Year auction, and coupled with the latest market selloff, there were few dark skies ahead of today's auction of $35 billion in 5 Year paper. Furthermore, suggesting today's auction would be very strong was today's repo market which saw the 5Y trading special at -0.15% on the curve, just begging for a short squeeze into the auction. That is precisely what happened.

The short squeeze into 10Y auctions never fails.

The internals of the auction were solid if not groundbreaking: the Bid to Cover was 3.233, fractionally below the TTM average of 3.286, the Dealer take down of 41% was the highest since February, while Indirects ended up withe 51% of the takedown, above the 45.7% TTM average. Finally, Directs were awarded just 8.0% of the auction matching the lowest since February. In short: a perfectly average auction, one which did not attract particular attention for any one reason. Which is why, tomorrow's 10Y auction will be far more closely watched.

With every passing week that money markets rates remain pinned to the zero bound by the Fed, the magnitude of the financial catastrophe hurtling toward main street America intensifies. When the next financial bubble crashes it can only be hoped that this time the people will grab their torches and pitchforks. Stanley Fischer ought to be among the first tarred and feathered for the calamity that he has so arrogantly helped enable.

What is going on here: is it just more seller than buyers, who are frontrunning an epic curve flattening or even inversion as may well happen once the Fed launches its rate hiking cycle? Or is something else happening behind the scenes. We ask because in addition to the normal selloff in cash and derivative products, something far more dramatic took place in the repo market where the repo rate on the 2Y just suddenly plunged out of nowhere.

In a January 2013 report “Report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans by NBFCs”, the Reserve Bank of India estimated that the ratio of paper gold trading to physical gold trading is 92:1. That is a lot of unbacked paper gold instruments. This has almost entirely separated the “gold price”, such as it is (the clearing price for vast volumes of paper gold “representations” with a fractional backing) from the fundamental supply and demand dynamics for actual physical gold bullion.

As Mr L. famously quipped. "Ever get the feeling you’ve been cheated?"

Overnight the Riksbank confirmed that it neither learns from its own mistakes, nor reads BIS reports when at 9:30 CET, it shocked central bank watcher all of whom were expecting no rate change from the bank, and announced it is not only engaging in yet another rate cut, taking the key rate even further into record NIRP territory, from -0.25% to -0.35% but adding insult to broken QE injury, it would expand its QE by a further SEK 45 billion starting in September. The reason? Sweden is realizing it is losing the currency war (to a great extent due to its failed QE which is pushing bond yields higher and with it, its currency) and it needs to soak up even more collateral... which can barely be found.

If you jump off of a make believe cliff, don't be surprised when you hit the reality of the ground! Reggie Middleton

For a glimpse of what happens next, look no further than Sweden.

In what amounts to still more evidence that investors are moving into derivatives in order to avoid illiquid cash markets, UBS finds that over the "past three months, daily average futures volume stands at nearly 70% of cash Treasuries, based on the notional amounts transacted... up from about 50% in 2011."

Successive rounds of government bond monetization have worked to destroy the Treasury, JGB, and EU core markets while the post-crisis regulatory regime has seen dealers back away from providing liquity in the secondary market for corporate credit just as the very same monetary policy that broke government bond markets has led to an explosion of new issuance from corporate borrowers, creating the potential for a self-feeding catastrophe in the event of selloff in corporate bonds.

The euro-19 area is now close to having a 100% debt to GDP ratio, and that’s flattered by German surpluses from an export boom that is rapidly cooling, and the fact the for a few quarters Mario’s printing press has conferred huge interest rate subsidies on their depleted fiscal accounts. The pending Graccident will puncture that illusion, tipping most of Europe into acute fiscal crisis and political upheaval of the type that has already roiled Greece and was starkly evident in Spain’s elections last weekend. The odds that the European superstate and the ECB’s Keynesian monetary regime will survive the resulting upheaval are, thankfully, somewhere between slim and none.

The Fed stimulates absolutely nothing but the media’s descriptions of it and the various economists and their models that depend solely on them being successful in doing so. If recessions are emotional and irrational pessimism as the monetary textbooks believe, then QE and ZIRP are just right sort of “happy pills” to push emotions back to the “right” direction. Is it any wonder the economy is in danger of sinking toward catastrophic failure?