“Wholesale measures [are] streaming in every few minutes”, Nomura’s Charlie McElligott writes, describing the deluge of contingency plans (monetary, fiscal and regulatory) adopted and announced on Friday in the wake of Thursday’s high drama across markets.
Nearly everyone is in on the act now. The Norges Bank cut rates Friday, the Riksbank announced new liquidity measures, the BoJ continues to make new pledges, the PBOC delivered another RRR cut, the RBA injected cash, South Korea banned short-selling and on and on.
All on the heels of Thursday’s Fed “bazooka“, and amid (still piecemeal) efforts from politicians to craft a coherent crisis response.
About that “bazooka”
You’re encouraged to remember that the Fed’s action served a dual purpose.
First (and most obviously), they were trying to ease a funding squeeze. Earlier Thursday, both the Fed’s 14- and 25-day term repos were oversubscribed and FRA-OIS and cross-currency basis have ballooned wider.
Every 14-day term operation since last month has been oversubscribed.
“Thursday’s price action in financial markets matched some of the most disorderly moves seen during the 08/09 financial crisis. Undoubtedly the sharp declines in global equity markets were exacerbated by dislocation in USD funding markets”, ING’s Chris Turner wrote Friday, adding that “the break-down in USD financing yesterday undoubtedly contributed to the out-sized dollar rally”.
The second “call to action” (as it were) is related (it’s all related, folks) but due in part to how quickly things unraveled, hasn’t received as much coverage. The Treasury market effectively malfunctioned this week, with myriad dislocations causing extreme consternation and very likely leading to blowups (see here and here).
McElligott reiterates that on Friday.
Fed liquidity actions “were introduced in an attempt to offset the obvious liquidity strains in the ‘frozen’ Rates space, as evidenced by the moves in basis/off-the-runs this week”, he writes, before suggesting that in order to mitigate the situation further and otherwise allay concerns, he expects the Fed to expand QE next week. (And remember, when the Fed said Thursday that, going forward, the $60 billion/month in asset purchases for “reserve management” will be “across a range of maturities to roughly match the maturity composition of Treasury securities outstanding”, that just means QE “proper”.)
“I expect them to announce next week that they will effectively double the current monthly $notional purchases in an effort to soak-up some of this liquidity strain as OTR’s remain largely ‘bid-less’ and a large problem for both dealers and the leverage RV community alike”, Charlie says, adding that Nomura’s house view is “that the Fed will cut 100bps next week, plus [an] additional $50 billion of purchases on top of the current $60 billion, plus the $20 billion from the MBS runoff reinvestments [for] a potential aggregate purchase of $130 billion/month from the Fed”.
As if on cue, the Fed announced they’ll buy $37 billion in bonds across the curve on Friday, out to 30-years. To wit:
To address temporary disruptions in the market for Treasury securities, the Open Market Trading Desk (the Desk) has updated the current monthly schedule of Treasury purchase operations. Today, the Desk will conduct purchases in each of five maturity sectors below at the times indicated, subject to reasonable prices.
- 20 to 30 year sector at 10:30 – 10:45 am and 2:15 to 2:45 pm for around $4 billion each
- 7 to 20 year sector at 11:15 – 11:30 am for around $5 billion
- 4.5 to 7 year sector at 12:00 – 12:15 pm for around $8 billion
- 2.25 to 4.5 year sector at 12:45 – 1:00 pm for around $8 billion
- 0 to 2.25 year sector at 1:30 – 1:45 pm for around $8 billion
“The current dislocations in the Treasury market would not be so severe if dealers had the balance sheet capacity to make use of all of the funding that the Desk has chosen to make available”, Wrightson ICAP economist Lou Crandall wrote in a note.
For what it’s worth, Goldman is now looking for a 100bps cut next week “in light of the continued growth in coronavirus cases in the US and globally, the sharp further tightening in financial conditions, and rising risks to the economic outlook”.
“The fact that the Fed was called in for these emergency measures will add weight to the view that the Fed will cut rates by 100bp next Wednesday and take no chances by announcing a new, large scale QE programme – a permanent liquidity add”, the above-mentioned Turner said Friday.
So, that’s where we’re at, folks. Rates to the ZLB (basically) next week, and an imminent expansion of asset purchases, which just became “real” QE less than 24 hours ago. And if you had any doubts about that transformation, Friday’s buying across the curve from the Fed should put those doubts to bed.
“The Fed is obviously deeply concerned about Treasury market functioning and is willing to do whatever it takes to try to backstop”, BMO’s Jon Hill remarked.
Release the risk parity kraken
Finally, if you’re wondering who to “blame” for Thursday’s massive deleveraging, it’s fair to point a finger at risk parity.
I spent a ton of time on that Thursday, but just to briefly revisit, McElligott writes that risk parity “was the story yesterday [and] by far the largest culprit in the cross-asset deleveraging purge”.
Indeed, Nomura’s model estimates aggregated gross exposure was cut “from 450% (61st %ile since ’11) down to 305% (2.9%ile) on the session”.
As one observer put it on Thursday afternoon, it’s “hard to escape the idea that the risk parity kraken has finally been unleashed”.