Nomura’s McElligott: We’re Seeing ‘Nervous Dollar Hoarding Demand’

“A senior administration official tells me ‘you may see action from the Fed today’ on short term credit for businesses”, CNBC’s Eamon Javers said Tuesday morning, adding that according to his source, it’s “under serious consideration”.

This is a testament to the notion that the Fed is aware of the extent to which the measures taken during Sunday evening’s “whatever it takes” moment from Jerome Powell were insufficient to address some of the clear and present dangers in the market, most notably funding strains showing up in, for example, commercial paper spreads.

In the simplest possible terms, corporates that can’t tap the commercial paper market may need to draw down credit lines instead. Then you end up with more headlines like those which rattled markets last week, when multiple companies announced plans to tap loan facilities.

Read more: Whac-A-Mole! Fed Faces Nightmare As Libor, Cross-Currency Basis Blow Out, CP Market ‘Frozen’

Funding stress is also showing up in widening cross-currency basis and, on Tuesday morning, the biggest spike in Libor since the crisis. As noted in the linked post, that’s pushing the dollar inexorably higher.

“DXY is the real story overnight, ripping higher in exponential fashion as USD funding pressure fears mount despite the positive optics of the coordinated global CB FX Swap line actions of the past week”, Nomura’s Charlie McElligott writes, in a timely Tuesday note.

(BBG)

Again, this comes even on the heels of Sunday’s action on swap lines which I immediately (i.e., on Sunday evening) flagged as the most important aspect of the myriad measures the Fed announced.

“Tomorrow will see the first USD operations from the ECB, BoE and SNB, so the overall take-up needs be impressive to show us that the Fed can get $$$ to those who need it most”, McElligott goes on to say, on the way to driving home the point above about the necessity of unfreezing the commercial paper market.

After noting that issuance had dropped off by 18% through late last week (and that’s surely worse now), Charlie reminds you that “the corporate cashflow strains are a massive issue with payroll and inventory requirements going forward”.

(BBG)

And so, the market was looking for imminent action from the Fed, which was facing the risk of being blamed for not intervening to prevent a scenario that finds everyone trying to become a “dollar hoarder” all at once, a wholly untenable proposition because, as Zoltan Pozsar wrote weeks ago, “the Fed [is] the only entity that can serve as a surplus agent to match the needs of a deficit system”.

Ultimately, the Fed did, in fact, reinstate the crisis-era commercial paper facility on Tuesday, opening up a vital lifeline for increasingly distressed corporates. You can read the full details in “Fed Reinstates Emergency Commercial Paper Funding Facility In Move To Avert Crisis“.

I’ll leave you with the relevant passage from Pozsar’s March 3 note:

A flood of corporate drawdowns could force the entire banking system into becoming a deficit agent — the extreme example of the outbreak infecting the top of the hierarchy: from firms to individual banks, to country level banking systems, to financial centers and, as contagion spreads and turns the global banking system into a deficit system, to the Fed — the only entity that can serve as a surplus agent to match the needs of a deficit system. No, that’s not an overstatement. We saw something similar in September!

Read more: Zoltan Pozsar Takes On COVID-19: ‘Use The Swap Lines, An Uncapped Repo Facility And QE’