This week’s oversubscribed repos may have been the “canary in the coal mine”, TD’s Priya Misra wrote, in a client note warning about the possibility that dollar-funding pressures could continue to build amid a worsening macro outlook.
Just prior to the Fed’s emergency rate cut on Tuesday, both the scheduled term repo and that day’s overnight operation were oversubscribed. It was the first oversubscribed O/N op since October.
The next day’s O/N op was oversubscribed too, and both term ops this week were three times oversubscribed.
On Friday, alarm bells began to sound as FRA/OIS continued to widen, raising the specter of interbank stress.
Colloquially speaking, that’s when things get “real” – when the plumbing starts to seize up and various measures of dollar-funding stress begin to flash yellow (or red), then we’ve moved beyond watching every tick in stocks. To quote former trade Richard Breslow again, “the USD FRA/OIS spread will tell you more… than the next percent or two in the S&P e-mini”.
We’re not in panic territory yet, despite my rather cavalier use of “Defcon 1” on Friday morning, but things were getting dicey headed into the weekend, that’s for sure. In addition to the rather dramatic two-session move in FRA/OIS (top pane), dollar swap spreads widened (bottom pane).
(BBG)
And then there’s cross-currency basis, which ballooned out for JPY to levels last seen in September (i.e., last seen at quarter-end Q3, as the 3-month tenor captured year-end).
(BBG)
The bottom pane just shows rates vol. moving sharply higher amid one of the most remarkable weeks in recent memory for bonds that culminated in Friday’s dramatic rally at the long-end that left even some seasoned traders flabbergasted.
One thing seems certain: The Fed will be reluctant to trim the size of its repos when the next schedule is released. TD’s Misra called any further reduction “very unlikely” and suggested we could even see the maximum on offer upsized.
Meanwhile, BMO’s Jon Hill conceded it’s possible the Fed may not end up tapering its T-Bill purchases after all. Of course, not doing so would clearly suggest to the market that we’ve moved well beyond a situation where balance sheet expansion is solely for the purposes of reserve management.
“To deviate from their tapering schedule would be to either tacitly acknowledge that it’s been shadow QE this whole time or further capitulate to some in the market’s interpretation of what the demand represents”, Hill said Friday, calling the possibility that the Fed never tapers its bill buying “non-zero” considering the Fed’s “extreme reticence to startle the market”.
It’s a little late for that, though. The market is already “startled”.
But up until this week, you might well have argued that the consternation was only manifesting in places where it didn’t really “matter”, so to speak. Places like equities. But if you start to see dollar-funding stress, that’s when things are at risk of crossing the Rubicon in earnest.
Somebody call Zoltan Pozsar — we’re gonna need another 17-page instruction manual.
Read more: Zoltan Pozsar Takes On COVID-19: ‘Use The Swap Lines, An Uncapped Repo Facility And QE’
