Late last month, BofA’s Mark Cabana sounded a cautious tone on what he’s calling a “combustible cocktail” that may create the conditions for another squeeze in short-term funding markets at the end of the year.
Specifically, he’s worried about reserve shortage and dealer intermediation constraints related to GSIB.
Cabana, you’re reminded, repeatedly warned that an episode like that which rippled across the repo market during the week of September 16 was likely imminent, prior to it actually unfolding.
Three weeks back, Cabana offered a series of potential remedies the Fed might deploy in an effort to ameliorate any potential year-end strain, one of which involved “ultra-long” term repos (i.e., tenors beyond the 14-day operations the Fed started conducting alongside the O/N ops following the September squeeze).
In addition to providing certainty, such a move would “push MMF away from dealers and into the FICC sponsored repo platform… add[ing] an additional source of cash that could be used to assist in stabilizing the repo market on year end”, Cabana remarked.
On Thursday, following Jerome Powell’s second day of “discussions” with lawmakers on Capitol Hill, the New York Fed announced some new longer-term operations, including two 42-day offerings of $25 billion and $15 billion, and a 28-day operation of at least $15 billion (the full schedule is below).
For Cabana, that ain’t gonna cut it – or at least not when it comes to nipping this in the bud preemptively. “This is not a ‘whatever-it-takes’ type of announcement”, he told Bloomberg. “It is a ‘let’s-see-how-it-goes’ type of announcement. That risks seeing additional funding pressures toward year-end”.
Cabana predicted the announcement of the longer-term operations in a note out just prior to the new schedule. “We see risks a faster pace of bill buying or longer term repos could be announced today at 3 PM with the Fed monthly operations schedule”, he said, in a short piece which also finds him recapping his concerns. To wit:
Low reserve level = the Fed is currently adding $205bn in reserves via repos even though they have bought $60bn of bills through their reserve management operations. The limited change in Fed repos since the start of bill purchases in Oct implies that UST leverage has not been reduced or the market is challenged to finance ongoing UST supply. Dealer intermediation constraints = dealers may need to reduce balance sheet and cross-jurisdictional repo as they approach Y/E to lower GSIB surcharges back to end ’18 levels. To hit GSIB targets dealers may be less willing to intermediate Fed repos to those that need the funding; the recent equity increase does not help.
The Fed kept the pace of monthly bill buying at $60 billion. Cabana in October suggested they may need to ratchet that higher in order to circumvent some of the issues he expects to see into year-end.
One option for fixing the situation is to relax some post-crisis regulations. Jamie Dimon hinted at that in JPMorgan’s third quarter call, and Powell mentioned it this week as well.
Sensing a push in that direction, Elizabeth Warren told Steve Mnuchin last month that he shouldn’t even think about testing her patience on the subject. “It would be painfully ironic if unexplained chaos in a small corner of the banking market became an excuse to further loosen rules that protect the economy from these types of risks”, she wrote, in a sharply-worded letter. Mnuchin subsequently suggested he might consider it anyway.
If you ask the Fed chair, this really isn’t something the proverbial Joe six-pack need concern himself with.
“We’re prepared to continue to learn and adjust, but it’s a process and it’s one that doesn’t have implications for the economy or general public”, Powell told lawmakers on Wednesday.
Famous last words?