Ground zero in many ways for the “dollar” stress going all the way back to June 2014 had been the repo market. This manifested in several ways, not the least of which was a series of largely unbroken surges in fails – denoting stress on collateral chains, availability and collateral liquidity. For the past several weeks (through the latest figures a/o 4-22-15), repo fails have gone back into submission. Dating back to the week of March 18, both UST and MBS fails have fallen in absolute terms as well as relative comparisons.
As to overall repo volume, DTCC figures suggest that too has been coming down after rising almost uninterrupted since October 15 of last year (the big liquidity event). I have surmised that this rising repo volume was not the credit system taking on more risk and larger positions, thus drawing up more from funding markets, but rather the tightening of bank balance sheet factors which have “forced” downstream participation toward repo as a last ditch means. In that sense, rising repo volume had indicated the same stress as repo fails, and like fails volume has fallen off recently which, in this interpretation, would be consistent with lower stress after mid-March.
But where those factors are indicative, potentially, of relenting in funding pressure, repo rates have been unusually volatile to the upside. That would seem to contradict the idea that funding pressure has abated, and suggests that there are still abnormal influences at work here.
Going back to the taper summer of 2013, we have become accustomed to repo rates surging into quarter and year-ends. That pattern was enormously amplified on March 31, at the end of the first quarter this year, which itself was conspicuous with GC rates the highest seen in years. Now, it seems, that even a month-end has unleashed the same kind of “window dressing” marking the first time for that. There is no good and obvious explanation for it.
Instead, the repo market, at least as far as published GC rates, is accumulating the kinds of ascending tendencies that have been consistent with policy or paradigm inflections. The view of rates against repo fails, for instance, while opposite at the moment is not entirely irreconcilable as these separate indications may be relaying different if related tendencies within the funding markets.
In some respects, this divergence seems to be picking up in other funding market spaces too. The eurodollar curve is intimately related to interest rate swaps, as they are in many ways different sides of the same coin. In more recent weeks, the eurodollar curve has pushed upward in the outer maturities back toward the more docile conditions pre-March 18.
While that might suggest on its face that eurdollar agents are preparing for the FOMC to raise rates, I actually think the more consistent interpretation is the opposite of that. In other words, the eurodollar curve was flattening as the FOMC was threatening to end ZIRP as an expression of doubts about what would happen if they did – that raising rates would be tantamount to economic and financial suicide. The March FOMC seems to be accepted recognition that the FOMC has become far less suicidal, and thus they will accommodate the economic “slump” without actually and further depressing into it.
That is why eurodollar rates are rising more in the outer years than the inner maturities, as implicit in that view is that the Fed will not raise rates soon and “allow” hopefully better economic fortune from it. It seems as if the eurodollar curve is suggesting that the “best case” is one where the FOMC does little or nothing about ending ZIRP.
However, in contrast, swap spreads are suggesting that illiquidity is still gaining. The divergence between the 5-year spread and 10-year spread continues to sharpen. There are a couple of interpretations that could be relevant here, and I think the one consistent with the repo market views is that there is an increase in hedging activity related to not the end of ZIRP but perhaps another QE. It was, after all, the 10-year spread that diverged from the 5-year in the middle of 2012 signaling both economic weakness and rising financial illiquidity that “brought about” QE3.
I think that point is emphasized by the hedging also taking place in TIPS, viewed via breakeven “rates.” Under the ZIPR/QE paradigm, inflation breakevens have almost nothing to do with “inflation” and are instead bets tied to what the Fed might or might not do. Again, the action of breakevens in tandem with the “rising dollar” and funding market stress suggested the “suicidal” interpretation. Since January 14 (and the SNB’s relenting of the franc peg to the euro), breakevens have been rising as if the SNB’s actions were taken as a sign that central bank resolve was not so locked in especially where those intentions were clearly creating massive problems of their own (as it was for the Swiss and their relation to the “dollar”).
In overall credit markets, however, there remains the same kind of pessimism that has been infecting the yield curve since November 20, 2013. While the “dollar” and funding pressures have clearly abated in some of these aspects, nominal interest rates and the yield curve shape has only very slightly reacted (with some of the bond selling this week and last very likely related to high volumes in corporate issuance taking away what little dealer liquidity is left at this point). There is very little to suggest newfound optimism in the face of this accepted convention about shifting FOMC views.
Taken altogether, I think what you get is credit markets that are still pessimistic about the economy and the gathering “slump” but have shifted as to the projected tendency of the FOMC to make it much worse. Instead, it seems as if parts of these funding markets both recognize these further problems as well as a solid interpretation as if US policymakers finally have accepted them. To that end, funding markets are suggesting both continued recognition of these bearish outcomes but also a small but definite increase toward hedging possibly for the next QE. I have maintained since the first one that eventually repeated QE’s would not be embraced as a “solution” full of hope and vigor but rather used as confirmation that it must truly be bad if the FOMC feels it has to be doing it again.
I suppose in one sense that is a positive, that the FOMC will not at least continue on its desperate course to make everyone “appreciate” how good a job they have done whether deserved or not, but how good can it be if funding markets and credit are actually preparing even just initially for the next QE? Three cheers that monetary policymakers have finally given up on the recovery and embraced the seriousness of the slump? There are, of course, many assumptions at this point taken within that analysis, but if anything has truly shifted since March 18 that would be it.