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Liquidity, Funding & the Gathering Storm

I tend to think about coverage of “Liquidity and the Funding Market” in the same way as “Child Stars of the 90s and the Eurotrash Nightclub Scene”. If they’re making headlines these days, it’s not because things are going well for Liquidity; it’s because they’ve been discovered face-down in a miasmic pool of ever-deepening turpitude & even their best friends are starting to get really, REALLY worried…

Which brings us to today.

Here’s a quick excursion thru arguably the most important funding spreads in the world:

1. December 2019 expiry FRA/OIS.

It’s the implied spread between where 3mL is expected to roll off vs spot->3mth OIS on 18-Dec-2019. Last year we rolled off on the Dec IMM date at 41, this year we’re already ~5bps above that – with another 3 months still to go. This spread has nearly doubled in the past 4 months.

2. O/N GC vs EFFR.

Single widest level since September 2008 – which is not exactly remembered as a time of bottomless liquidity for the funding market.


Fed effective now printing +4bps over IOER. The last time it got around these levels, the Fed saw fit to intervene with an IOER adjustment in order to “fine tune” the level for Fed Funds. This was the third time they’ve had to intervene in such a way. That means if they had to do it once again in order to combat the rise in effective, they’d be only one more IOER cut away from the lower bound.

Any one of the above charts at these kinds of levels would be cause for alarm. All three at once paints a very dismal picture for liquidity in the most important market in the world as we head into the end of the year.


Now, the reasons behind the move appear to be yet another perfect storm in the front-end of the curve:


It’s possible that the massive move last week triggered an unwind of assets that were “parked” in repo. This should in turn exert upward pressure on repo markets & push funding spreads wider. It would also mean that this is likely to be fairly short-lived.


Corporate tax day & heavy bill supply settlements also blamed for the specific timing of this latest move.


As markets digest more Treasury supply the same time US G-SIBs (Global Systemically Important Banks) are looking to contract their balance sheets to lower their G-SIB surcharge score by the year-end measurement date, this should cause dollar funding conditions to tighten further from here.

Keep an eye on Page 6…

Some of these will revert (unwinds, timing, etc), but the biggest drivers – an oversupply of collateral during precisely the same period of time that US banks are most actively attempting to drive down their balance sheet – will remain in play for the next few months.

Ironically, the silver bullet to all this – a standing repo facility – has been subject to a lot of talk but very little action or concrete timing from the Fed. They are, in fact, still very much actively interviewing for someone to step into this role (after the former head of this division clashed so violently with the newly minted New York Fed President that they sent him packing, whilst enroute to a conference in Hong Kong earlier this spring.. fun fact).

If we don’t get some kind of much more substantive discussion on the topic Wednesday, you should expect to be reading a lot more about this topic in the weeks & months to come. Liquidity in funding markets only really matters when it’s not there.

As with Lindsay, I pray for the best. But I’ll still occasionally check Page 6.

Just in case.

For more on the gathering storm that’s brewing in front-end markets, please see here & here:

References, Sources : Bloomberg, HFR Research, SocGen Hedge Fund Monitor, CME Group.


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