Repo Market

From the first headline to the last, the following brief month-by-month summary of the year shows just how far markets and global happenings have come...

UPDATE: 7-day repo is now up 220bps at 980bps - as the "liquidity crisis" is worse than any other seasonal effect on record

How do you "fix" a nations' banking system's increasingly desperate need (and dependence upon) for government-provided liquidity without giving in and just providing all the inflation-stoking liquidity the banks demand? Simple - in China - you ban the media from discussing it. As The FT reports, Chinese propaganda officials have ordered financial journalists and some media outlets to tone down their coverage of a liquidity crunch in the interbank market, in a sign of how worried Beijing is that the turmoil will continue. The censors have warned reporters not to "hype" the multiple-sigma spikes in overnight-funding rates and have forbidden the press from using the Chinese words for "cash crunch."

As we showed very vividly yesterday, while the world is comfortably distracted with mundane questions of whether the Fed will taper this, the BOJ will untaper that, or if the ECB will finally rebel against an "oppressive" German regime - with $3.5 trillion in asset (and debt) creation per year, is China. China, however, is increasingly aware that in the grand scheme of things, its credit spigot is the marginal driver of global liquidity, which is great of the rest of the world, but with an epic accumulation of bad debt and NPLs, all the downside is left for China while the upside is shared with the world.  Which is why it was not surprising to learn that China has drafted rules banning banks from evading lending limits by structuring loans to other financial institutions so that they can be recorded as asset sales.  And while we are confident Chinese financial geniuses will find ways to bypass this attempt to curb breakneck credit expansion in due course, in the meantime, Chinese liquidity conditions are certain to get far tighter. This is precisely the WSJ reported overnight, when it observed that yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing's relentless drive to tighten the monetary spigots in the world's second-largest economy.

Ben Bernanke is participating in an IMF panel with Larry Summers, Ken Rogoff, and fromer Bank of Israel chief Stan Fischer... Full speech below...

"We see upside surprise risks on gold and silver in the years ahead," is how UBS commodity strategy team begins a deep dive into a multi-factor valuation perspective of the precious metals. The key to their expectation, intriguingly, that new regulation will put substantial pressure on banks to deleverage – raising the onus on the Fed to reflate much harder in 2014 than markets are pricing in. In this view UBS commodity team is also more cautious on US macro...

A mere 24 hours before the US was going to run out of money and default on its obligations (in what Jack Lew described as a "catastrophe"), Grant Williams notes the S&P 500 was trading exactly 2.30% from its all-time high. Does that sound like anybody was worried about financial Armageddon? Nope, but as Williams detail sin his latest letter, the danger was very real, as a default by the US on its debt obligations would have gone to the very heart of the "plumbing" that underlies financial markets and caused havoc in the repo market and all kinds of problems with collateral... The key clue passed most people by a week ago; but it came from, of all places, Hong Kong...

• Congress Vote Ends Impasse to Be Revisited in January (BBG); Congress Passes Debt, Budget Deal (WSJ)
• House GOP extracts no concessions (Politico)
• Washington becomes the biggest risk to the U.S. economy (Reuters)
• Debt Deal Seen Boosting U.S. Consumers as Holidays Approach (BBG) - only thing missing: disposable income
• Federal Employees Head Back to Work (WSJ)
• Regulator Suggested Shift for Dimon at J.P. Morgan Unit (WSJ)
• Twitter hires Google ad exec ahead of IPO (CNET)
• Teens can now post publicly, but posts are friends-only by default (WaPo)
• Germany Moves to Finalize Coalition Deal (WSJ)
• Draghi Turns Judge on EU Banks as ECB Studies Accounts (BBG)
• UK nuclear deal with China a ‘new dawn’ (FT)

While stuff like soaring Bill yields, the threat of Money Market funds breaking the buck, and the gradual phase out of near-term money equivalent collateral thanks to the complete dysfunction in Congress which has managed to breach the repo market into "good" and "bad" Bills, may be too arcane to the various JPY-correlating, ES-ramping algos, those who care about real signals, now that the US flirtation with the X-Date is hours ago may be interested to know that according to ICAP, as reported by Stone McCarthy, overnight General Collateral, the key rate in the determination of collateral pricing for trillions worth of assets, just exploded once again and in following the surge in Bill cash rates, hit 0.32%, the highest since December 7. Indicatively, at 0.32%, GC is now well above both overnight LIBOR (10.69 bps) and the Fed Funds rate (10 bps).

This objective report concisely summarizes important macro events over the past week. It is not geared to push an agenda. Impartiality is necessary to avoid costly psychological traps, which all investors are prone to, such as confirmation, conservatism, and endowment biases.

The dollar is the world’s go-to currency. But for how much longer? Will the dollar’s status as the only true global currency be irreparably damaged by the battle in the US Congress over raising the federal government’s debt ceiling? Is the dollar’s “exorbitant privilege” as the world’s main reserve currency truly at risk? Sane governments do not default when they have a choice – especially not when they enjoy the “exorbitant privilege” of issuing the only true global currency. We are about to find out whether the US still has a sane government.

While there is hope that DC will engage in its favorite, can-kicking activity any minute and if not resolve then at least push back the funding and debt ceiling stalemate by a few weeks, the reality is that without a deal in seven days, there may be no cash to pay down maturing Bills starting with the October 17 issue whose yield soared to nearly 50 bps yesterday. The reason for the capitulation as was revealed yesterday, is that various money market funds such as Fidelity's have been selling all paper around the X-Date. This morning the contagion surrounding the use of Bills as collateral has crossed the Pacific, following news that the "Hong Kong’s futures and options market operator will require traders to put up more collateral when using some Treasury bills to back their positions, citing concern that the U.S. is at risk of a default." In other words, as we forecast on Monday, the debt-ceiling confusion in cash-land has now openly engulfed the repo market, which only makes the states of a debt deal that much higher. Because if the repo, $2.5 trillion money market, and subsequently, the entire $80 or so trillion custodian market freeze up, what happens next will make Lehman seem like a quiet walk in the park.

As we first pointed out, yesterday's stunning, near-failure in the 4-Week Bill auction, was the straw that broke the illusion of the market stability's back and as even Goldman pointed out, led to the first true "fear-driven" drop in stocks. Today, things are getting from bad to worse, as it is not the Halloween Bill, but the October 17 issue that is getting Friendo'ed as can be seen on the chart below - the 10/17s just hit 42 bps, a nearly 20 bps move in minutes! But while disturbing, what is going on in cash is just the beginning of the story. It is what is going in the shadow markets that could really light the fireworks on fire.

On September 26, when we wrote "As US Default Risk Spikes To 5-Month High, Here Is How To Trade The Debt Ceiling Showdown", we suggested a simple 1M/1Y Bill flattener, which has since resulted in a massive profit to those who put on the trade with appropriate leverage, leading to the steepest outright inversion the short-end curve has seen on record. For those who engaged in this trade, it may be time to book profits and move on, as the risk of a negative catalyst - a shutdown/debt ceiling resolution - gets higher with every passing day that we move closer to the October 17 X-Date. However, those who wish to remain engaged in the short end of the bond market where the highest convexity to the daily newsflow can be found, one possible alternative trade is to shift away from cash markets, and into shadow banking, via the repo pathway.

Yesterday we described the various scenarios available to Treasury in the next few weeks should the shutdown and debt ceiling debacle carry on longer than the equity markets believe possible. As BofAML notes, however, the most plausible option for the Treasury could be implementing a delayed payment regime. In such a scenario, the Treasury would wait until it has enough cash to pay off an entire day’s obligations and then make those payments on a day-to-day basis. Given the lack of a precedent, it is hard to quantify the impact on the financial markets in the event that the Treasury was to miss payment on a UST; but the following looks at the impact on a market by market basis.