Pale Rider?

Our unprecedented in depth coverage of the repo ruckus continues, following up on The Man With No Name in Part 9: High Plains Drifter?

to know money from mud, one must know the difference in stock vs flow, and a debit from credit. 

This week's UST auctions at avg. 3X bid to offer; on settlement dates 11/07 $345 bln; 11/12 $285 bln; 11/15 $252 bln avg. for a total $882 bln liquidity drain, speaking of which... And behold a sickly pale market which no one can make, and he that sat upon it, left many bereft and hell followed with him...

With the Pale Rider in mind... Did anyone even bother to splain what repo is and why one might engage in it?  Let's see what the "Jamie Gang" has to say...

The first signs of the financial crisis bubbled up in this corner of the market, also dubbed the lifeblood of Wall Street by the press, when dealers could no longer roll their significant repo exposures as liquidity rapidly dried up.

After Lehman Brothers failed, banks and regulators recognized the risks associated with short-term funding, both unsecured and secured, and ushered in a new series of rules. - A Primer on Sponsored Repo - JPM

Indeed, in the +$5 trn RP, and +2.3trn RRP market there are many nuances and distinctions. Much like the graphics above, we will limit our Nattering to that which is applicable for our purposes. The reader should think of the opening quote re: money, and motives.

A cash-driven transaction is one where the collateral seller (provider) is seeking to borrow cash.  In cash driven repo: collateral buyers (cash lenders) use reverse repo to lend cash.  Collateral sellers (providers) use repo to borrow cash.  Why are those collateral sellers (providers) driving the RP bus to borrow cash?  Liquidity management to fund trading inventory, and or covering long positions in, long hedging of, or arbitrage against short cash or derivative positions.

A collateral-driven transaction is one where the collateral buyer (cash lender) is seeking to borrow securities.  In collateral driven repo: collateral sellers (providers) use repo to lend collateral.  Collateral buyers (cash lenders) use reverse repo to borrow collateral.  Why are those collateral buyers (cash lenders) driving the RRP bus to borrow securities? Avoiding repo fails, and or covering short positions in, short hedging of, or arbitrage against long cash or derivative positions.

Did somebody above mention risks associated with strictly short term funding? As for risk mitigation, hedging reduces but cannot eliminate risk, and changes the character of risk i.e. hedging with collateral transforms credit risk into operational and legal risk.  Among the many risks, risk free collateral is sometimes viewed as a complete substitute for counterparty credit risk, and collateral may generate unexpected losses.

Last but not least, FX swaps are comparable to repo, and out of cost and/or necessity, oft utilized as a substitute. Legally both involve the immediate "sale" or pledge and future repurchase of assets or flows and thus economically both create an exchange of loans. Foreign exchange (FX) derivatives, FX swaps, currency swaps and closely related forwards, create debt like obligations which allow a non US entity to exchange non dollar cash flows for dollar cash flows, and are functionally equivalent to borrowing and lending in the cash market. 

NIM compression already leads to chasing yield in unstable alternatives to deposits viz. substitution for insured deposits. Recent reductions in IOER might have spurred some actors to dabble elsewhere with their ample reserves, with unintended consequence?  Perhaps why all three EFFR and SOFR based upon REPO have been less than stable since March 20th? - High Plains Drifter?

Think of motives, one can avoid the collateral and risks by synthetically creating repo, and accommodate non US entities at the same time? Does it get any better? Albeit potentially at an increased cost? Sometimes yes, sometimes no...  

A dealer receives a total of about 230 basis points for what is a synthetic yen-dollar repo. That includes the three-month dollar Libor rate, the negative rate on Japan Libor, a charge by the dealer called the ‘basis’, and the negative yield on the JGBs which are the best place for the dealer to park the yen they receive in return for dollars. Compare that to dollar repo which was 190 earlier this week, and Treasury bills, which are about 150. You can see why the dealers are incentivised to lend dollars in the FX swap market rather than the domestic money market. On several trillion dollars 40bp or 50bp is a lot of incentive for the dealer banks to lend into FX swaps rather than repo. - Derivatives To Crash Markets Again? - FT

Too good to be true, where's the downside?  The short duration on most FXS and forwards can create duration mismatches.  Unlike most derivatives, FXS does not rollover and the full notional amount is exchanged at maturity. Those factors can create liquidity demand and funding squeezes, such as the Euro banks during the GFC.  However, an FX swap is accounted for like a derivative, so it is off balance sheet which is at a premium, not to mention what happens in the Bermuda Triangle, stays in the Caymans?  Speaking of which...

For whatever reason(s), there’s been a truly massive increase in US bank liabilities [TIC] in the form of other securities (CLO’s) belonging to non-bank foreign agents [$1 trn]. At the very same time, for whatever reason(s), there’s been a slightly larger increase in US bank liabilities being held in custody for domestic customers [$800 bln]... And much if not most of whatever’s going on is being run through the Cayman Islands. Custody. CLO’s. Caymans. Domestic and foreign nonbanks. Shadow repo transformation? A gigantic collateral call? - Ticked About TIC: The Accidental Discovery of Perhaps The Big Bottleneck - Jeffrey Snider - July 17

Tip-o-the-hat as Snider was on it. Per TIC data, since April 2017 when LCR went into effect, total custodied for the Cayman's alone went up +$541 bln from $235 to $776 bln. Somebody got sick and tired of "The Big Bottleneck" and not enough repo to go around, and decided to outsource? That's quite the pawn shop operation, to the tune of half a trln? Imagine financial institutions dabbling in unstable alternatives to deposits or repo such as FX swaps or synthetic repo?  And now this...

Above, since Oct 2018 USD Forward Swaps collapsed. In particular note the BIG V at the trough. The big V... Jul 30 = 1.983 to Sep 4 = 1.357 decline 0.626 over 26 trading days avg -0.024 per day.  Aug 5, 6, 7 were the three largest daily declines in history. To put this in perspective, each of those day's was 28% larger than the Nov 20, 2008 single day Lehman decline which ranks #8 all time. And then the bounce from Sep 4 through lucky Friday Sep 13 = 1.757 rebound 0.400 over 7 trading days = +0.057 per day. 

A whole bunch of custodied CLO's (onshore and offshore) are starting to smell like a can of rotten sardines (think currency hedged, negative yielding, inverse floater deals that went the wrong way). That's The Signpost Up Ahead? - Sept 16

One might think that wicked V ride or rapid whipsawing, spun and popped the cork on quite a few USD FX related synthetic repo derivatives trades. It's no wonder the repo ruckus hit on Monday Sept 16th?  Coincidence? We think not. With all that Nattered, let's run this bad dog down... 

"Long term yields should drop further, quarter end rucks will cause short duration funding cost spikes (cost of loan funds), especially in September (think in anticipation of Chinese banks closing for golden week Oct 1st)... Seasonal monetary flow factors were already set to collapse into the 2nd half. Additional liquidity drains: TGA restock, $1T UST issuance by YE."  
- 08/12 Fed Cuts: Accommodative?

Fed QT shrinks Fed balance sheet; -$1.4 trln excess reserves parked at the FRB's; 09/13 -$21bln MMF outflows; 09/16 $100bln corporate tax pymts; 09/18 Japan on holiday; 09/11 - 09/18 +$120 bln TGA increase; $80bln UST auction settlements; month, quarter end,  seasonal monetary flow trough approaching; and additional UST supply coming down the pipe i.e. July - Sept $440bln; Oct - Dec $352bln; Jan - Mar $389bln.

our biggest remaining UST buyers outside the already over bloated primary dealers are completely out, so look out below... a dearth of dollar "liquidity" stemming from a dearth of dealer balance sheet capacity, could turn into a major shit show, and soon. - 09/16 That's The Signpost Up Ahead?

With advance knowledge of the above and balance sheets bloated with UST's, dealers draw down their cash (reserves). Short cash dealers have to raise additional cash in repo (with existing inventory) to come up with additional clearing balances to buy the new issuance.  

a bunch of cash flowed out, while a bunch of debentures attempted to flow in, creating a mismatch. For A Few Dollars More? 

This rotated the dealer HQLA portfolio away from cash and towards o/n repo to UST's, turning dealers into net borrowers in the o/n repo market, which raised cash rates. This increased need reduced funds available for market making, increased the markets funding gap, and the excess collateral float.

non operating deposits = money market funds, repo, commercial paper AND MOST IMPORTANTLY bank deposits considered in "excess" of operational "need".  Notice what is omitted from the list? UST's, how convenient? - The Good, The Bad And The Ugly?

At a certain point the alphabet soup regulatory disintermediated banks hit their intraday HQLA liquidity limits, and remaining reserves were allocated towards regulatory needs, and the repo market was left to wait.

Lacking any margin buyers, there will be little to no balance sheet capacity for those dealers to fund or make other market activities, think the non banks. - 09/17 Nuance and Timing?

What about o/n FF market actors? Volume in o/n GC repo dwarfs o/n FF so an aggressive bid for o/n FF from arbs could eliminate the spread between o/n FF and GC rates. In addition, lower IOER (High Plains Drifter?) impacts foreign demand for reserves, chasing the foreign banks out of IOER arbs which are channeled through o/n FF.  Any contraction in the o/n FF channel would impact reserves raised in o/n FF, which get lent in the FICC cleared o/n GC repo market to help absorb excess collateral in the system.

In the meantime, those dirty double dealin varmints deployed reserves to dabble in offshore synthetic repo, and other balance sheet shenanigans, where everyone on the wrong side of the trade got torched in the USD swap collapse and whipsaw.

At the end of the day, a confluence of all the above for a perfect storm as a surge of collateral through a constricted sluice caused ill liquidity, which gapped up o/n GC rates higher and higher until they exceed the target range, and the Fed sheriff got called in.  Whew, that was one hell of a ride, end of story?  You oughta know better by now, like a dog with a bone which is not ready to be buried, not so fast Joe, or you finish outside...

There is something in this more than natural. As we learned today, there is more than meets the eye, and things lurking in the shadows that can go bump in the night.  The  repo process graphics which appeared above courtesy of JPM, much like our stylized explanation of the process, leave out a whole lot of down and dirty details, and one might reflect on the highlighted quotes.

There is nuance and distinction with regard to intermediaries, their relationships and trust or CON-fidence, especially with all the chit being passed around. Something is rotten in Denmark. Is this really where the path of the Pale Rider takes us?  More to come as the Man With No Name attempts to conclude his ride down this long and dusty trail in Part 11: Sad Hill Unearthed? Stay tuned, no flippin.

Recommended Reading:
A Fistful Of Dollars?
For A Few Dollars More?
The Good, The Bad And The Ugly?
A Coffin Full Of Dollars?
A Dollar To Die For?
The Devil's Dollar Sign?
The Million Dollar Bloodhunt?
Blood For a Dirty Dollar?
High Plains Drifter?
A Negative Disposition?
A Wayward Italian in Kansas?
First Rule Of Bond Market: You Do Not Talk About Keynes?
Nuance and Timing?
Ruck This?
That's The Signpost Up Ahead?
Fed Cuts: Accommodative?
Half Baked Hopes Souffle?
Reserves, RRP and The Libor Squeeze?
A Primer on Sponsored Repo - JPM
Ticked About TIC: The Accidental Discovery of Perhaps The Big Bottleneck - Jeffrey Snider
Swaps data: analysing the US rates collapse - Risk.net
Derivatives To Crash Markets Again? - FT
FX swaps and forwards: missing global debt? - BIS