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My core thesis right now is the US G-SIBs are being stuffed to the gills with coupon USTs. 1/x
I& #39;ve done a rather poor job of describing the situation that gave rise to said stuffing, and will try to rectify that. Specifically, I& #39;ve conflated description of primary dealer and bank portfolio gill stuffing. 2/x
When you aggregate all UST holdings from US G-SIBs, you get the following (note that only $JPM has 3Q filings are complete, but others should w/in two weeks). As you can see, $JPM has added $152bln of USTs in last 4Q& #39;s, but they& #39;re not alone. 3/x
Every G-SIB save for $BK and $STT (which are custody banks, so special cases) have added double-digit billions of USTs in prior 3Q& #39;s, likely more when the new data is available. 4/x
The data above are BHC aggregates. Here& #39;s what I& #39;ve done a bad job describing and defending: A decent amount of this stuffing comes from PDs& #39; trading accts, but another big piece is HQLA portfolios. Note 3Q 2019 data is $JPM only. 5/x
In fact, based on @federalreserve holdings data (more frequent than the above qrtly fin& #39;l filings), what is looks like is that PDs have been selling trading assets into banks& #39; HQLA portfolios. Weird huh? We& #39;ll have more evidence when the other G-SIBs file. 6/x
"Why" PDs and bank HQLA portfolios are loading up with USTs is complicated, but essentially my view is that they& #39;re the cash asset buyers of last resort. And assuming these entities follow their usual gameplan, they& #39;ve hedged most interest rate risk. 7/x
Just b/c they& #39;re essentially forced buyers doesn& #39;t mean that PDs and banks& #39; aren& #39;t profiting off of UST holdings. Negative swap spreads mean 5yr UST can be swapped back to L+3.5bps. 8/x
While I doubt many G-SIBs want this big of PD/HQLA UST holdings, it& #39;s tolerable, as the L+3.5ish spread can be levered up many times, especially since foreign funding of the repo market is quite willing (even if foreign buys of coupon USTs are low). Yup, I said repo. 9/x
In any case, BHC aggregate coupon UST buys have their limits, whether they& #39;re done at the PD level (where obligated to buy) or at the HQLA level. At the current rate of net adds ($50bln/mth) funded by repo, those limits are defined mainly by LCR at the BHC level. 10/x
USTs are 100% HQLA for the numerator of the ratio but repo outflows is bad for the denominator of the ratio, and funding term UST with o/n repo decreases the LCR. So basically there& #39;s a limit to how many USTs US G-SIBs can absorb. 11/x
At the current rate of UST buying (~$50bln/mth), G-SIBs will find LCR limiting in 1Q 2020. Meanwhile @federalreserve has started buying up T-bills, seemingly missing out on the fact that intermediate to longer coupon USTs are the real problem. 12/x
Economically speaking, the risk is that BHC aggregate balance sheet holdings of USTs crowd out BHCs& #39; ability to lend to private credit markets. That includes PDs providing liquidity to bond/loan transactions and banks providing net lending at the margin. 13/x
Why? The easiest way to improve LCR ratios in the face of growing coupon UST holdings is to eliminate non-HQLA assets which require funding, such as corporate bond or loan holdings. Recent big underperformance of lev loans and CCC credit may be a piec of that trend. 14/x
If that theme continues, @federalreserve views LCR tightness --> credit contraction not as a technical problem of excess UST supply on BHCs, but as evidence of deteriorating financial conditions...and we get more insurance based rate cuts as soon as 1Q 2020. 15/x
Funnily enough, these cuts also solve underlying prob of foreigners not funding $1.1tln budget deficit, as lower front end & steeper curve reduces FX-hedging costs AND incentivizes real money buyers to leave o/n repo mkts and come back into coupon USTs. 16/x
The path to that point might be volatile for risk assets, but there& #39;s no reason the Fed can& #39;t save the day again. Fin.
PS: I hope these comments clarify recent threads in which I& #39;ve been unclear. CC:
@Barton_options
@kimgits1
@deepwatrcreatur
@dandolfa
@kimdriver11
@mattwaters
@an10nev
@MonetaryWonk
@Barton_options
@kimgits1
@deepwatrcreatur
@dandolfa
@kimdriver11
@mattwaters
@an10nev
@MonetaryWonk
