Author: YGAMN&chdr
Source: Global Market Detector
Yesterday the Federal Reserve restarted the primary dealer credit mechanism PDCF (Primary Dealer Credit Facility), which will provide overnight funds to major traders, similar to the way the discount window provides depositors with backup funds. Primary traders can mortgage a range of investment-grade bonds including commercial paper and municipal bonds as well as stocks to obtain financing .
At the same time, the Federal Reserve launched another tool, Commercial Paper Funding Facility (CPFF). Currently, the coronavirus outbreak has interrupted the cash flow of businesses and companies need to raise cash. Meanwhile, money market mutual funds (regular buyers of commercial paper) are also trying to raise cash to deal with investors’ redemptions. The reintroduction of CPFF has made the Fed a big buyer of commercial paper and should help stabilize the market .
Although the Fed initiates PDCF and CPFF, liquidity tension in the banking system has not eased. FRA/OIS spread still soars.
At the same time, the US Treasury Department's $1 trillion stimulus and helicopter money (a check of $1,000 per person) brought the US ten-year Treasury bond back above 1%, and the risk of US sovereign debt increased dramatically.
helicopter spending money may cause the dollar to eventually weaken, but for now, liquidity is crucial, and the liquidity crisis in the financial system has caused the dollar to soar again . The dollar has risen for six consecutive days, and today is the largest single-day gain since the Brexit referendum in June 2016 (and the largest 6-day gain since Lehman Brothers).
repo market Zotlan Pozsar of Credit Suisse, a major in the repo market, wrote in his latest report:
The Fed's liquidity injection does not seem to have much effect. All areas of the financing market - Secured, unsecured and currency swap markets are still showing increasing pressure. The Fed needs to do more.
According to our observations, some time ago, the US government did not require large local commercial banks to help the real economy like other countries. Now American banks are also asked to do so, and the dollar financing market is beginning to be hit. As companies use the credit line in advance, banks provide more loans to households and businesses, and loans consume banks' balance sheets and venture capital, which has forced banks to reduce market making and arbitrage trading .
As banks exit market making, the Federal Reserve and other central banks need to assume the role of the last trader.
· The Fed needs to be the buyer of large certificates of deposit (CDs) and commercial paper (CP), rather than through CPFF.
·The Federal Reserve needs to provide US dollars to other central banks through currency swaps every day, and then other central banks need to provide US dollars to banks and non-bank institutions.
·The Fed needs to expand the scope of currency swaps to other countries except the G7, because there is also a lot of demand for the US dollar in Scandinavia, Southeast Asia, Australia and South America. Offshore banks and non-banks that require dollar financing are at risk, and the assets they finance purchase are dollar assets (such as US Treasury bonds, MBS and credit assets), so the Fed has a vested interest.
A relatively popular strategy for the global financial order in the post-quantitative easing period. Non-bank institutions from negative interest rates such as life insurance and asset management companies raise low-interest financing in the region, purchase assets such as treasury bonds and credit assets in high-interest areas through currency swaps, and hedge against the risks brought by exchange rate changes. These non-bank institutions are the new shadow banking , and the scale has been growing for a long time. Carry trade has enabled capital to run around the world, and this time, global central banks have to save shadow banking again.
Zotlan Pozsar is more concerned about:
2. The transaction frequency of currency swaps between the Federal Reserve and central banks of various countries has been swapped for the period;
3. Financing needs of non-bank institutions;
4. Currency swap protocol does not include.
Pozsar pointed out the initial impact of the large-denomination certificate of deposit (CD) and commercial paper (CP) markets, was due to the collapse of the stock market and the flow of funds caused by the flow of funds, and funds flowed from the cash collateral reinvestment account of the priority money fund to the short sellers’ account. In other words, due to the collapse of the stock market, money funds will sell the CDs and CPs they hold and buy Treasury bonds safe-haven . And these happen exactly when the issuance of CPs and CDs of enterprises and banks increases. To date, the outflow of priority money funds has been small, but given the continued pressure in the financing market and intensified risk aversion, more funds are likely to flow out of priority money funds this week to safer government money funds. This rotation will further reduce demand for CD and CP this week and put pressure on the spread of Libor-OIS.
This explains why Pozsar believes that the right solution now is not to reactivate CPFF like the Fed, because SPVs in CPFF will only purchase commercial paper/large certificates of deposit with a grade of at least A-1/P-1/F-1. Pozsar's proposal is to get the Fed to reach an agreement with the U.S. Treasury Department to provide a "first loss buffer" for any financial or non-financial CP/CD purchased by the New York Fed in the primary or secondary market. The first loss buffer will ensure that the U.S. Treasury bears credit risk, while the Fed only bears liquidity risk, making the Fed feel that the funds released are safe enough—this is the Fed’s biggest concern in a crisis situation.
The account used to pay for the first loss buffer of this type of funds already exists in the Ministry of Finance’s ordinary account. Using $50 billion of the $400 billion of idle funds as a loss buffer is enough to make the Fed feel safe and provide instant support to the market - Bank of Japan and Bank of Canada have purchased CPs within their national jurisdiction.
Secondly, the currency swap transactions between the Federal Reserve and the G7 central bank have become active, but the operational improvements are still needed. Now the transaction frequency is once a week, with a three-month duration, which should be improved to daily and provide a shorter period, as the Fed operates in the repo market.
Again, the Fed's currency exchange protocol is only open to banks . The currency swap agreement was initially used in 2008 to meet the bank's funding needs: the Federal Reserve raised US dollars to other central banks, which were then loaned to banks. But since the financial crisis, non-banks have replaced banks as the largest borrower in the currency swap market . Unless non-bank institutions can obtain US dollars in the central bank's dollar auction, if the bank does not act as an intermediary, the interest rate spread of currency swaps will still be large. In other words, the released US dollar liquidity cannot reach the target audience .
In addition, this transmission mechanism is becoming increasingly risky, because the assets of funds using currency swaps include not only treasury bonds, but also credit and CLO. Credit in various sectors is deteriorating rapidly, which makes it more risky for traders to fund certain life insurance companies through currency swaps.
Finally, the Fed's currency swap protocol needs to expand the scope from G7 , and for various reasons, the dollar demand for Sweden , Norway , Denmark , Hong Kong, Singapore , South Korea, Taiwan, Australia, as well as Brazil and Mexico US dollar demand seems particularly amazing. Institutional investors from Scandinavian countries need the dollar to hedge, and only Norway has a large amount of foreign exchange reserves available. Mexico needs the dollar to cope with the trade shock caused by the plummeting oil price. Southeast Asian countries that act as banking centers require US dollar liquidation, etc.
In short, the Fed's dollar swap needs to go global and the hierarchy must tend to flatten.
