0:10

Hello, and welcome to another episode

0:13

of the All Thoughts Podcast. I'm Tracy

0:15

Alloway and I'm Joe.

0:18

So Joe, it's uh, well, there's

0:20

been a bit of drama in the treasury

0:23

market once again. Yeah, I noticed.

0:25

Um, you got to do one of your Tracy

0:28

Elloway signature things where

0:30

you talk about a move that happened that's always

0:32

supposed to happen like once every three billion

0:34

years. Yes. Um. I love talking

0:36

about those because it really gives everyone the opportunity

0:39

to show that they've read to Leb's books

0:41

by saying that the world isn't normally distributed.

0:44

But of course we did see some pretty

0:46

big moves in the treasury market. So first

0:48

of all, the ten year yield

0:51

jumped up to one point six

0:54

percent. This was in the last week of February.

0:57

But the really big move came

0:59

in the five five year and I think

1:01

that one had something like a seven

1:03

or eight standard deviation

1:06

move, you know, one of those things that's only supposed

1:08

to happen in like ten billion years kind

1:10

of things. And really, I

1:13

know people make fun of standard deviations

1:15

and sigma events, but really we're talking

1:17

about the world's most liquid market

1:21

and stuff like this keeps happening.

1:23

This is I think the fourth

1:25

big about of treasury

1:28

market chaos that we've had in just a couple

1:30

of years. So I'm thinking back. We had

1:32

one in um what was it September?

1:35

We had Rebo madness, Then we

1:37

had the March chaos in with

1:40

the levered U S. T trades blowing up, and

1:42

then we had a mini rates blowout

1:45

in October, and

1:47

now we just had the most recent incidents.

1:49

So something is

1:51

going on, and clearly there

1:53

is a persistent issue in the U S. Treasury

1:55

market. Yeah, there's a lot of things

1:58

going on at once these day is

2:00

because there seems to be ongoing

2:02

structural issues, questions about liquidity,

2:05

which is weird in a the world's most

2:07

deep and liquid market, and be a

2:10

market in which the FED is actively

2:12

supplying a lot of liquidity, are very

2:14

active in the market. And then of course

2:16

it's interacting with

2:18

the economic situation and the policy

2:20

situation, because we have this FED that

2:23

said we're not going to raise rates until the

2:25

economy hits these benchmarks, and everyone's

2:27

washing to see the FEDS credibility. We

2:29

also have a very out rapidly improving economy.

2:32

We have people warning about inflation for the first

2:34

time, So all kinds of things happening

2:36

at once. But yes, to your point, the

2:39

big action we've seen. We've

2:41

seen rates at the long end, ten year, thirty

2:43

year yields have been rising for a while since the middle

2:45

of last year, but it's really

2:47

the action at the shorter end that's striking

2:49

here. Yeah. And of course, one of the weird

2:51

things about last week is you mentioned the economy,

2:54

but we have this big tantrum in bond

2:57

yields without a corresponding

3:00

taper. I guess, so we kind of had a taperless

3:02

tantrum because not that

3:04

much changed last week. We didn't

3:06

have FED speakers talking about

3:08

rates rising or anything like that, but we have

3:10

this huge move in the bond market. So

3:14

a lot of focus on microstructure at the moment,

3:16

a lot of focus on liquidity, ease

3:18

of trading, and the overall

3:20

organization of the treasury market. And we have

3:23

the perfect person to talk about

3:26

all those things. We're gonna

3:28

be speaking with Sultan Posar from

3:30

Credits with I can't wait, Let's

3:32

do it. Yeah. Um so, Sultan, I

3:34

should say, in addition to being a

3:36

strategist over Credits, has also

3:39

been on the All Thoughts podcast multiple

3:41

times, so we will be getting

3:43

you that tote bag any day now,

3:45

Sultan, thank you so much for coming on again.

3:48

Thank you very much for having me. I should just

3:50

say one more thing, which is that every time there's

3:53

any volatility in the rates market, someone

3:56

I bas me it says, you guys got to

3:58

get result on again. It happens every

4:00

time anything takes higher on some screen

4:02

of like overnight funding rates to whatever

4:05

they're like, when do you have exulting back on the episode?

4:07

So this is a lot of requests

4:10

for this one. Sorry, go on. Okay,

4:13

Well, on that note, I mean, why don't we start

4:15

out with a big questions? So every

4:17

time there's some sort of chaos

4:20

in the rates market, Joe gets an I be asking

4:22

for you to come on the show. There's been a lot

4:24

of those over the past couple of years,

4:26

and as we were discussing, that's

4:29

something you wouldn't necessarily expect

4:31

for the world's most liquid market. So what's

4:34

going on here and why do we

4:36

keep getting these sort of many

4:38

blow ups in rates? I

4:41

think people get shaken out of their positions

4:44

all the time. I mean, just through

4:46

just to me, who set the set the stage for

4:48

the conversation. I think there's there's a number

4:51

of things that are happening, um that

4:53

has happened last week, for a number of

4:55

weeks now and really since the Democratic

4:58

win and the Blues the you

5:00

know, the treasury curve has been steepening quite

5:03

remarkably, I mean relative to uh

5:05

the slope of curves in Germany, in

5:07

France and Japan. You know,

5:09

the U s treasury curve has gotten quite steep

5:12

for a number of reasons. You had, you

5:14

had the Blue sweep. You have

5:17

the vaccine rollout, which is you know, happening

5:20

in the US more rapidly

5:22

perhaps than in other parts of the world. You

5:24

have the market starting to price in

5:27

recovery, the market

5:29

trying to price in the inflation outlooks,

5:32

and the market is you know, getting excited

5:35

about the idea that with inflation, bill surely

5:37

comes from that action, and that is going to you

5:39

know, try to chase down inflation and keep it in check.

5:42

And so all of these things I think have driven

5:45

the steepening of the curve. But you know,

5:48

the interesting thing is that the steepening of

5:50

the curve has been fairly orderly,

5:52

okay, And so what happened last week was

5:55

a little bit plumbing related, but again

5:57

the the the underlying structural driver

6:00

of rising yields has been more

6:02

fundamentally driven. What happened last

6:05

week, I would say that there were two central

6:07

banks that were quite

6:09

a bit in the headlines um last

6:11

week and and that got the markets a

6:13

little bit kittery. I think there were some headlines

6:15

around, uh, the r B n Z, and

6:18

there were some headlines around the r B A, you

6:20

know, with the r B and Z. I think what

6:23

what didn't help the situation was the

6:26

market interpreted the headline that

6:29

the Finance Minister of

6:31

New Zealand has forced a new mandate

6:34

on on on the Reserve Bank

6:36

of New Zealand because you know, house price targetting

6:38

and house prices have been through

6:40

the roof in New Zealand and so hikes are coming

6:43

because of that, which is which is absolutely

6:45

not the case. I mean, you know, the RBNZ is policy

6:47

mandate is pretty much unchanged. I mean, they have their price

6:49

stability mandate, they have their U

6:52

full employment man, they have their financial

6:55

stability mandate. And all that has happened is that

6:57

that financial stability mandate getting more

7:00

explicit peace to it, which is,

7:02

you know, looking at house prices more

7:04

carefully, um in the future,

7:06

particularly house price dynamics

7:09

driven by second home buyers and

7:11

investment property buyers.

7:13

That was number one. Number two UM,

7:16

the r v A had breached a

7:18

youth curve target, okay, and so

7:20

the market was looking very closely at

7:23

the three year point in the in

7:25

the Australian government bond market and

7:27

it got you know, one basis points to basis

7:29

point three basis points higher than

7:32

the yield curve target. And the RBA didn't

7:34

truly do anything. And

7:37

so because the RBA was so slow

7:39

to respond to to to the

7:41

breach of that youth curve target, UM, I

7:43

think the market got quite spooked by

7:46

that. You know, Australian accounts

7:48

did try to get long Australian

7:50

bonds, but you know, things were moving so fast

7:53

and prices were getting so much that they

7:55

got you know, limited down very quickly. So if

7:58

you couldn't take advantage of the sellout in the US really

8:00

and yields, what a lot

8:02

of account in Austrailia have done is they

8:04

have rather shorted US U

8:06

S treasuries. And so now we are in

8:08

a Tuesday Wednesday time frame, and

8:11

then by the time we got to Thursday in the US,

8:13

we had a scheduled seven year auction UM

8:16

and that auction went absolutely

8:18

horribly. It was, you know, one of

8:20

the most undersubscribed in recent

8:22

memory. I forget how far you have to

8:24

go back to find something as lowly subscribed.

8:27

And you know that also had some technical

8:30

drivers do it because you know, in the US we

8:32

are in this kind of Noman's land from

8:34

a from a regulatory perspective, where

8:36

the bank portfolios that

8:38

are normally have a big presence in

8:40

in these in these auctions have been

8:43

a bit on the sidelines. Laterly because there's

8:45

a big question mark in the US regarding

8:47

you know, the SLR treatment of

8:50

of treasuries. You know, is it going to get expended

8:52

the exemption from the SLR or not um

8:55

So, so there was a lot of uncertainty

8:57

about that. And then you know you mentioned the five year

9:00

point. I mean, it so happens that,

9:02

you know, one a popular trade in the

9:04

US has been you know, people shorting the

9:07

five year and being short the five year and along

9:10

the thirty year, and you know, as all

9:12

these rates market dynamics were happening

9:14

and the market was, you know, questioning

9:16

central banks commitments to low

9:19

rates for a long time. I think you know, people

9:21

were just shaking out of these carry positions.

9:24

And you know, we have a financial system

9:26

that is highly levered because

9:29

race are solo, right, so one way of generating

9:32

a decent amount of return with

9:34

low risk, low yielding assets as you lever it

9:37

up, and every time you have a change in expectations

9:39

and your understanding of the world and for

9:41

how long the central banks are being to stay accommodative,

9:44

you get shaken out of these positions

9:46

and and things are quite

9:49

volatible when it happens. So there's

9:51

obviously quite a bit going

9:54

on here, and I the way you laid it out

9:56

is really great. And of course it seems like a classic

9:58

finance thing that even

10:01

though there's a lot of different things, somehow it randomly

10:03

gets kicked off by policy

10:05

choices at the Reserve Bank of New Zealand

10:07

or the Reserve Bank of Australia and then it spills

10:10

into their You mentioned the

10:12

SLR and the questions about that, and

10:14

in fact, some of the I V s that I get

10:16

when they're like when they want to hear you on it's

10:19

specifically about that what

10:21

is it. I'm aware that something, some decision

10:24

has to be made at the end of this month. It's going to

10:26

affect bank liquidity, but sort

10:28

of describe what this sort of

10:30

this ambiguity that's hanging over the market

10:32

is and how that is affecting UM

10:34

rates, market liquidity. So

10:37

this is a big topic. I'm you know, trying

10:39

to think through how to attack the question.

10:41

Okay, one, you know, you know

10:43

there's lots of ambiguities, right, So you

10:46

know, first of all, we have an exemption currently

10:48

in place which says that

10:50

you know, reserves just cast

10:53

of central banks and treasuries

10:55

that are bank holds are exempt

10:57

from calculating the the

11:00

supplementary leverage ratio. So

11:02

this these leverage ratios are much higher because

11:05

of that now, and that exemption

11:08

UM was put in place in April one

11:10

last year, and it's set to

11:12

expire at the end of

11:15

this month, March thirty one, and

11:18

so no one knows whether it's going

11:20

to get extended, whether it's

11:22

going to be renewed temporarily

11:25

or or if it's going to whether it's

11:27

going to get extended permanently, whether it's going to

11:29

get taken away. You know, a

11:32

letter from Senator Brown and Senator

11:34

Warrenberg in the headlines today, Um,

11:36

you know they've sent them a letter to to the Federal

11:39

Reserve arguing against making

11:41

this exemption permanent. There

11:43

are ideas that have been put

11:46

forth by the Professor

11:48

Daryl DARYLD Duffy at Stanford

11:50

that you know, maybe only reserves

11:52

should be exempted permanently,

11:55

but not treasuries. That

11:57

would be more in line with the global

11:59

stand undered where you know, the ECB has exempted

12:02

reserves, the SMB has exempted

12:04

reserves, but that exemption by the way ended

12:06

at the end of December. Already

12:09

in the Bank of England exempts reserves,

12:11

so that would be more in line with the

12:14

international standard. But you know, the downside

12:16

of that would be that you know, the banks would be

12:18

forced to sell treasuries

12:20

because you know, if your balance is constrained,

12:23

um, and only reserves are exempt from

12:25

the SLR, and you bought a lot of treasuries

12:27

last year, then you will have to sell all

12:30

those treasuries. So that's that's what this

12:32

this uh, this uncertainty is. You

12:34

know, when it comes to the SLR, really there's

12:36

really two things that

12:38

you want to think about the first is

12:41

that we are not done with que and

12:43

we are not done with you know, the

12:45

wall of cash hitting the banking system. Right, So there's

12:48

two things on the horizon that

12:50

we are focused on. Number One, treasuries

12:52

cash balances are coming down.

12:55

I mean, you know, that's one point six

12:57

trillion dollars of cash sitting

12:59

in a in a in a bank account that at

13:01

the at the Federal Reserve. And and as

13:04

those balances come down, reserves in the banking system

13:06

are going to go up. And number two,

13:08

QUEE is ongoing, and it's a hundred and spenty

13:11

billion dollars a month. So you

13:13

know, at face value, if all the Treasuries

13:15

cash banances come down to zero, and if QUI

13:18

proceeds this year, we are going to be adding two

13:20

to three trillion dollars

13:22

of cash into the banking system.

13:25

And so the banking system does

13:27

not have the balance sheets to take

13:30

on two three trillion

13:32

dollars of cash

13:34

without SLR relief, you know, so the

13:37

thinking goes. And then the other

13:39

problem is that you

13:41

know, the ban on stock buy backs ended,

13:44

and the banks are you know, getting ready

13:46

to return capital to shareholders

13:48

and and and if you. If

13:50

you buy back stock and this SLR

13:52

exemption does not happen, then

13:55

you basically are in a position where the

13:57

banking system is going to return

14:00

and capital to shareholders that would otherwise

14:02

have been used to take on

14:05

more reserves and and and and treasuries

14:07

in the in the system. So when we talk

14:10

about this SELLR exemption, we kind of think

14:12

about it as this magic bullet that's

14:14

going to allow the banking system to

14:16

take on two or three trillion dollars

14:19

of reserves. So let's

14:21

assume that the seller exemption happen. You

14:23

know, this stellar exemption really matters for

14:26

the for the handful of big banks that

14:28

that really are key for for U S fiancial

14:30

system. And these banks are JP

14:32

Morgan, whilst Fargo City Bank, Bank

14:34

of America I would perhaps put

14:36

you know, P and C in the bucket as well. So

14:39

these are these are the banks that are the big

14:41

repositories of deposits and

14:43

reserves and treasury securities, and

14:45

they are the banks that have been underwriting the

14:48

fiscal and monetary extension all of

14:50

all of last year. So so let's assume

14:53

that we do this SLR exemption. So what would

14:55

happen. Would you know a bank like

14:57

JP Morgan be in pole position

14:59

to put on another five hundred billion

15:01

dollars of reserves at the FED and another

15:04

five billion dollars of deposits

15:06

as the stimulus checks go out. The answer

15:08

is no, because you

15:10

know, JP Morgan has two constraints.

15:13

It has an SLR constraint and

15:15

it has a g SIP constraint. So even

15:17

if you exempt reserves and treasuries

15:19

from the SLR, you know that bank is

15:21

still not going to be in a position to take on massive

15:24

amounts of new deposits and additional

15:26

reserves and additional treasury securities

15:29

because that would push their GCIP

15:31

score and their GIPS surcharged

15:34

from four percent to four and a half percent. You

15:36

know, and their management has repeated a

15:39

number of times that they don't want to have a higher

15:41

g SUP score and they don't want to higher

15:43

capital ratio than's about an a half percent. Okay,

15:46

so you know, SLR exemption or

15:48

not, you know, JP Morgan is not in

15:50

a position to take on

15:52

a large amount of additional reserves.

15:55

So that's number one. Number two. You know, well

15:58

far ago the bank that I have been

16:00

writing about a lot recently.

16:02

Well Fargo is is in a unique situation

16:04

because they are under an asset growth

16:06

ban okay, and they have

16:08

been put into that place because of

16:11

you know, past issues they have had

16:13

and a SAD has put them

16:15

in in this asset growth band position. So

16:17

you know, the the analogy there is if

16:20

you if you think of the US financial system

16:22

as a seven for seven, a Boeing seven for seven,

16:24

it's really had been. It really has been flying

16:26

on three engines because the fourth engine,

16:29

you know, it's just not working at

16:31

the moment. That that's well Fargo. You

16:33

know, if you have an SLR exemption, you're still

16:35

not going to help wellth Fargo because they can't grow their

16:37

balance sheet much, okay. So that's that's the

16:39

second bank. The third City Bank

16:42

is you know, it's a unique creature,

16:44

right because it's half global, half US.

16:47

It's mostly an institutional bank, not a retail

16:50

bank, so it doesn't have as big a retail present as

16:52

as JP Morgan or Bank of America.

16:54

So you know, all the stimulu structs are going

16:56

out and all these cashes coming into the system.

16:59

You know, they're the posit growth is

17:01

you know, not going to be uh as big

17:04

as it would be for JP Morgan and Bank

17:06

of America. And you know the other thing about cities

17:09

that they have slatlined their balance sheet since

17:11

the third quarter of twenty twenties,

17:13

so they haven't really been growing their balancie that

17:16

much. Then we have Bank

17:18

of America, which is a bank that would absolutely

17:21

benefit from an SLR really because they don't

17:23

have a GC issue like

17:25

UM JP Morgan

17:28

UM. And you have you know, PNC Bank, which is

17:30

which is a large regional bank

17:33

when you would say probably borderline national bank

17:35

because it's so big, and so you basically

17:37

have two banks that would be the primary

17:40

beneficiaries of of an SLR

17:42

relief. Then you need to stop there

17:44

because every time the SET makes

17:46

a decision about SLR

17:49

relief and all these changes to

17:51

the Basle three architecture, they

17:53

do something called a impact

17:55

study, and the aim of

17:57

this impact studies to basically um

18:01

quantify you know, what type of a

18:03

quantity benefit does the system get

18:05

by doing this route change. And

18:08

you know, if you come to the conclusion that

18:10

of all these large banks that we're trying to help,

18:13

we are only going to benefit one or two, not

18:16

the entire class of Jesives,

18:18

should we really do this or be getting

18:21

a lot of mileage out of out

18:23

of sl release. And I think you know the answer

18:25

there is is not really because

18:28

again you are going to be looking at five banks

18:30

and really only two of them are going to

18:32

be able to absorb a

18:34

lot of reserves and treasuries. And when you look

18:36

at the scale of things to come, you know, to the

18:39

three trilli and a additional liquidity, you know, it's

18:41

clear that even those two banks are not going

18:43

to be able to absorb all

18:45

of that liquidity, you know. So, so observation

18:47

number one, you know, how

18:49

do you justified when when

18:52

the when the universe of banks

18:54

that can benefit from this on scale,

18:57

your ability to add balance

19:00

capacity to the system is is not that big

19:02

to begin this. I think that's definitely

19:04

one thing that they are going to uh

19:07

they are going to look at the second

19:09

because you know, everything that we talked about is basically

19:11

about how do you absorb

19:14

the additional cash that's going to

19:16

come into the system this year.

19:18

The second aspect of of it is

19:21

is this um the ALAR

19:24

exemption is is very important

19:26

from the perspective of stock

19:28

buybacks. Right, so a lot of these banks will say,

19:32

um, we have a lot of excess capital, and

19:34

what that means is that they have a lot of excess capital

19:37

relative to res created assets. UM.

19:39

You know, rescreated assets are basically

19:41

loans and you know the bank's credit portfolios,

19:43

but loans have not really been growing and

19:45

the banks has had a stock

19:47

by back band that has been in place since the

19:50

first So basically all all net

19:52

income that the banking system has been generating for

19:54

the past twelve months has been retained

19:58

UM and you know that added

20:00

to banks capital base. So

20:03

uh, you know, when the banks are saying that we have a lot of access

20:05

capital, that access capital relative to risk

20:08

weated assets, but it's not access

20:10

capital relative to all the reserves

20:12

and the treasuries that have been accumulated

20:15

last year. As as the fiscal and monitor stimulus

20:17

get under way, and so you know,

20:19

slur exemption there is essential for

20:22

the banks to be able to start returning

20:24

some of this excess capital UM

20:27

two shareholders. But again, you know that's

20:29

a capital return aspect and

20:31

not necessarily that

20:34

will make it easier for the banks to return capital

20:36

shareholders, but it won't necessarily

20:38

add you know, balance the capacity

20:40

to to to the system, and I think that's why this

20:42

makes it so complicated as a decision

20:44

for the FAD. So

21:02

I guess to two related questions.

21:05

One during the February

21:08

bond market drama, like, how

21:10

much did SLR concerns

21:13

way on dealers,

21:16

um in your opinion? And I know that you like to

21:18

call around a lot of the banks and sort of

21:20

pick up market color when these things happen,

21:23

So I'm just curious how much that came

21:25

up. And then secondly, what

21:28

could the FED do to sort

21:30

of relieve balance sheet pressures instead

21:33

of extending the SLR if you think

21:35

that it's not necessarily the

21:37

most efficient way of doing that. Okay,

21:42

Well, um, I think I think the way

21:45

last week in the treasury market and

21:47

and and the SLR question

21:49

are related. It's actually not through

21:52

not through the dealer balance it's it's basically the bank

21:55

portfolios that you want to think about, right, So,

21:57

every every large US bank is going to

21:59

have a dealer subsidiary and what's

22:02

called the bank operating subsidiary,

22:04

and it's the banks that have all the reserves

22:06

and all the treasuries. The dealers have obviously

22:08

a treating book that but that in a grand scheme

22:10

of things that that's tiny. So when you look

22:12

at an auction that goes bad, okay,

22:15

a large part for that that auction is

22:18

basically because the bank portfolio doesn't

22:20

show up, because the bank portfolio doesn't know

22:22

what's going to happen to this SLUR exemption.

22:24

You know, management is getting the

22:26

balance is ready for stock by

22:29

backs. If you want to buy that stock you

22:31

basically and an SLR exemption does not

22:33

happen, then you will

22:35

be you know, throwing balance with

22:38

capacity away to basically

22:40

carry liquid assets. And

22:42

if you do that, you know, it's much better to do that

22:45

when you have less treasuries and more reserves.

22:47

So you know, the the the the SAR

22:50

exemption angle here is just basically, you

22:52

know, had this a stellar exemption being

22:55

resolved already and and if

22:57

we have clarity on it, and you know maybe if

23:00

had you know, extended permanently,

23:03

you know, then the banks would have been I guess

23:05

more present at the auction and so things

23:08

would not have gone um that

23:10

that you know what happens with with again,

23:12

you know, the these these carry traders getting shaken

23:14

out of their positions. You know, the dealers are going

23:16

to kind of intermediate these things. But

23:19

you know, in real time, I guess

23:21

you know, you always have these air pockets that

23:23

the dealers have to intermediate to. And when the

23:25

flows go one way and then quickly the other way,

23:28

I mean, it's never a smooth process. But I

23:30

would not say that, you know, dealers

23:32

intermediation capacity was

23:35

impaired by any means, because

23:37

because of these SLR deliberations,

23:39

it's more like a bank portfolio. Do I show up

23:41

at the auction and takedown of treasuries or or

23:44

not? He had a second question, trat, but

23:46

I forgot, but that was Oh. So

23:48

the second question was if the SLR,

23:50

If extending the SLR exemption

23:53

isn't the most efficient way of fixing

23:56

this problem, what could the FED

23:58

or regulators do instead? Again,

24:00

I think, I think you have to you

24:02

have to go back to QUEI one

24:05

and QUEI Q one too. Que E three.

24:08

You know that two thousand and eight

24:10

to twenty fifteen period to

24:13

see how the system absorbs

24:15

liquity. Uh that's

24:18

put in by central banks. You know. The reason why I

24:20

bring up Q one to que E three is the

24:22

stats balance. It expanded back then a great deal

24:24

too, but half of the liquidity

24:26

went to the large American banks

24:29

and the other half has gone to the

24:31

foreign banks. What makes last

24:33

year an anomaly is

24:36

that all of this liquidity that was punned into

24:38

the system went to the American

24:40

banks, and it stayed with the American

24:42

banks. You know when you look at you know, the for

24:45

foreign banks holdings of reserves at the said

24:48

it's been largely flat. Okay, So

24:50

you you now basically have two case studies

24:52

where you know, we have a big downpour

24:54

of liquidity, it's all going to the American banks,

24:57

and then we have another downpour of liquity earlier

24:59

in history where half of we spent here,

25:01

half aw spent there. What is going to

25:03

happen if the American banks are going to have

25:06

balanchet constraints, Well, the

25:08

system is going to adjust. Um.

25:10

You know the stimulus checks that are going to come in,

25:13

Uh, those are going to be hitting people's bank deposits.

25:15

You know, these are all retail deposits

25:18

that every bank loves. And you

25:20

know when the stimulus checks go out, you know it's obviously

25:22

going to be JP Morgan and Bank of American and

25:25

and all these big national banks that are

25:27

going to be getting it. But that's going to put

25:29

them in a position where if

25:31

they have a fixed quantum of balance sheets, because

25:33

that's a lot really doesn't happen, then

25:36

they are going to have to take a hard look at their

25:38

deposit base and say, okay,

25:40

well we are getting good retail deposits. We

25:42

have some institutional deposits to

25:45

some of it operating, some of it non operating,

25:47

non operating. It's basically access cash that

25:50

these institutions just parked with these

25:52

large banks. And then you know, the bank is going to be in a position

25:54

where they are going to have to turn some of

25:56

these institutional deposits away.

25:59

There's a number of ways to to doing that.

26:01

I mean, you're basically dealing with corporate treasurers,

26:03

so you know you will pick up the phone and try to negotiate

26:06

with them. You know, I can't really hold it in the

26:08

bank, but would you mind moving it over to my asset

26:10

management arm and putting it into a money fund

26:13

or if that doesn't work, you can't put a put

26:15

a fee on you know, these

26:17

deposits. Some of the banks are doing

26:19

this already. Um, I'm not

26:21

going to mention hich Bank, but one bank,

26:23

for example, in January started

26:26

to charge institutions for the posit

26:28

balances that are above their December

26:30

thirty starts level. And you know, there's just

26:32

applied way of saying that, Look, if

26:34

you place more cash with me, there will

26:37

be a fee associated with that. So you

26:39

know, that's that's one way of encouraging depositors

26:42

to move cast from one bank to

26:44

another, or from from the banking system

26:46

too to to two money

26:48

fund. And then the third thing you're gonna do

26:51

is you're going to move your deposit trade negative.

26:54

And you know this is not this

26:56

is not theoretical because if you look at

26:59

um JP Morgan's fourth

27:01

quarter learnings presentation, you know they have a

27:04

very interesting slide on this that you know, we

27:06

we are now approaching balance sheet constraints.

27:09

We have all these deposits coming in. The

27:11

only assets really we can deploy these

27:13

deposits into is cash at the FED which

27:15

earned stand basis points. Or

27:18

we can buy treasuries, which you know,

27:20

at the tenure point it yields great, but otherwise,

27:23

you know, treasuries are not not really a good good

27:25

investing opportunity. And thanks to begin that,

27:27

they're not very excited about dying treasuries and

27:30

you know, these are all very low r OV type

27:33

activities UM and low r o E means

27:35

you know, you're diluting your your bank's

27:38

performance. And you know, if you have a fifteen percent

27:40

r o WE target and all the balance

27:42

sheet growth that you're getting is happening

27:44

in the in the in these low spread

27:47

assets, then you basically

27:49

dial with your your banks r o WE. So

27:51

you know, the point of this this page in the

27:53

learning presentation was that for us

27:55

to improve the economics of our business, given

27:58

all this downpour of liquidity and the system expansion

28:01

that the set is forcing on the banking system,

28:03

we will have to move or de consitrates

28:05

negative because that's the way that we are

28:07

going to be able to meet our our earning

28:10

s targets. And so you know, when you bring

28:12

in this negative the consit traits

28:15

idea into the picture, then

28:17

you know the the the picture you know, starts

28:20

to fall together because what's happening here is

28:22

that as the licutity comes in and

28:24

the banking system becomes balance sheet constrained,

28:26

they are pushing the money away into money

28:29

funds and the bill market because not everybody

28:31

is going to want to invest in in money

28:33

funds. And so you know, the

28:36

the idea of negative bill yields,

28:38

which is, you know, a regime

28:40

where we are that your borderline

28:42

in already. You know, this regime of

28:44

negative bill yields goes hand in hand

28:46

with negative deposit traits

28:49

or fees on bank deposits because

28:51

you know, there's so much cash to the banking system just

28:53

doesn't want to hold it. And you know

28:55

that money is getting pushed around in the system

28:57

and we are just trying to find home

29:00

for it. And you know, I'm giving

29:02

you a very long winded answer, but basically, what

29:04

are what is the technology to basically deal with

29:06

this? You know, technology quote unquote. You

29:08

know, we have a tool for this, which is the reverse report

29:11

facility. Right, all the money

29:13

that is going into the money funds,

29:15

I mean, the money funds need an asset to invest

29:18

this catch into. And so you

29:21

know, really it would be as simple

29:23

as whatever the money the banking system

29:25

doesn't want and the money fund get, the money fund should

29:27

be able to place in the reverse rey pro facility

29:29

one for one. But there's one problem with this

29:31

reverse rey port facility. It's capped

29:35

at thirty billion dollars per counterparty,

29:37

which means that if you're a large money fund and

29:39

you have fifty billion dollars of inflots

29:41

coming at you, because you know, Jping

29:43

Morgan just pushed away fifty billion dollars of deposits,

29:46

you will only be able to put thirty billion of that in the

29:48

reverse rey pro facility, and that remaining

29:50

twenty you will be investing

29:53

at rates below that, you know, potentially

29:55

at negative interest rates. You know, then

29:58

the money funds can get into a situation where

30:00

if I can invest at negative rates only

30:03

my marginal inflows, I'm not going

30:05

to want that money because you know, money fund is not

30:07

supposed to break the buck, and not breaking

30:09

the buck is is possible only if

30:12

yields in your investment

30:14

universe or above zero. So

30:16

a number of money funds that you talked to the especially

30:19

the larger ones, are contemplating

30:22

gating inflows and basically

30:24

shutting the door to new

30:26

money. And then you get into a

30:29

dynamic where the bank doesn't want to get the money,

30:31

the money fund doesn't want to get the money. So then the

30:33

bill market remains this kind

30:35

of alternate shock absorber that's

30:38

going to take the inflos, and that's how

30:40

you get to negative bill yields

30:42

basically between now and in the

30:44

beginning of summers. What is

30:46

it that the SET can do. The SET could simply

30:49

uncap the use of this RRP facility,

30:52

and I think that would go a great

30:54

length to to ensuring that there

30:57

is a flexible supply of

30:59

asset for the money

31:01

fund complex where you

31:03

can invest cash at least at zero Or

31:06

you know, the FED wants to raise the the r A P

31:08

rade from zero to five basis points, then you have a marginal

31:11

asset for for the for the money

31:13

fund complex that pays five basis points.

31:15

And then and then you don't have any of these issues.

31:17

And you know, that's why I have been arguing in

31:19

in my in my recent pieces that far

31:22

more important than raising the price

31:24

on the reversaryport facility is

31:26

to uncapt the use of that facility, because

31:29

you know, if you can only place x amount of five at

31:31

five basis points, once you're beyond

31:33

that amount, you will be lending cash

31:35

at rades less than five basis points. And you still

31:37

get into this dynamics that it's talking about.

31:55

So we've been talking a lot about

31:58

plumbing, obviously, and this is sort of, uh,

32:00

the key story and the issue

32:02

of like where to put all this extra cash and the

32:04

lack of vehicles to place it. You

32:07

know, we just have we have a few minutes left before we

32:09

go. I want to get back to something. You know

32:11

in your first answer, we talked a little bit also

32:13

about positioning and how low rates the

32:16

only way to compensate for low rates is

32:18

leverage. Some of the issues with Australian

32:20

investors having to short the

32:22

U S. Treasury market to sort

32:25

of hedge the fact that the

32:27

the belly of the Australian curve was blowing

32:29

out. Let's go back a little

32:31

bit to that, and how much is that part of the story

32:34

of this sort of concentrated positioning

32:36

um C t A flows uh.

32:39

And how much is that part of the story that

32:41

we've seen, and how much of that is still

32:44

built up? How much pent up sort of

32:46

tension is there? And how much is that dissipated

32:49

with last week's shock. Look,

32:51

I think I think a lot of it has.

32:54

The positions have shrunk, right,

32:56

so short of the belly along

32:58

the back end, I think those positions

33:02

have been downsized, um

33:05

relative to last week.

33:07

I think I think we also had

33:10

this again this episode of you know, what's

33:12

how committed our central banks

33:14

to keeping you know,

33:16

in the case of the r B a rates in

33:18

the belly anchored. And I think you know, the

33:21

central banks have spoken loud and clear. You

33:23

know, the ECB has spoken loud and clear about you

33:25

know, they don't want any of their yields going

33:28

higher. Either. The set hasn't really said

33:30

anything. And frankly, you know, I

33:32

don't think I don't think that they should. I mean maybe

33:34

even even I was I was a bit

33:36

too fast last week, you know, saying that, Well,

33:39

one thing that the fest could do is a talk

33:42

rates down, do something like an operation

33:44

twist, you know, self front

33:46

and stuff and buy back and stuff to the police

33:48

belong and but but here's the point, you know,

33:50

the long and you don't really need to police because

33:53

what you have seen is that you have this massive

33:55

sell off. But then you

33:57

know, the the the fics hedged bys

34:00

that we talk a lot about on this show,

34:02

at least when I come on, is

34:05

you know, they are now getting a beautiful

34:07

amount of slope in the treasury

34:09

curve. And and again keep in mind every time

34:11

you talk about all these cash coming into the system,

34:14

you know, Bill yields going negative. That means

34:16

that these hedging costs are going to be very

34:18

well anchored and if anything, they are going

34:20

to be going going lower. So basically,

34:23

you know the sell off that happened last

34:25

year, you know, some guys were shaking out of their positions,

34:27

but that was an opportunity for another set of buyers

34:30

because if you look at these effects hedged yields,

34:33

I mean we are back to levels where we had last

34:35

time, being in twenty fifteen. And

34:38

you know that's just great because you know when you look at

34:40

yields in Japan and you look at

34:42

yields in Europe, I mean those are still abysmal.

34:45

Right, So any fixed income allocator is

34:47

going to look at these types

34:49

of sell offs um with great

34:51

excitement. And that's that that was a

34:54

part of the self healing mechanism. And you

34:56

know, on Thursday we had a bad day, but Friday

34:58

and since then we've been having uh

35:01

you know, great great price section in in treasury.

35:04

So again, you know, some people win, some people

35:06

lose, But I don't think that that

35:09

the sets should do anything about

35:11

this. And again, you know, I think I think there

35:14

will be a couple of these um

35:16

instances where you know, as the

35:18

inflation narrative and the reflation narrative

35:20

is not going to go away anytime soon. You

35:23

know, that's going to drive field curve

35:25

dynamics. I think you know that's that's a part of

35:27

the that's a part of the future

35:30

out But I'm not sure that you know, the said

35:32

should do anything explicit

35:34

about it. I think, you know, even even

35:37

I think I even regret saying,

35:39

let's be that, you know, one of the things that the pet

35:41

should do, they talk it down, be do

35:43

operation twist im And sometimes you get bound up

35:45

in the emotions of the markets. You know, the

35:47

market has theres a lot of you know, self

35:50

healing properties, right and again,

35:52

you know, the losses for some investors were

35:54

an opportunity for the ATHLETs buyers

35:57

later on, you know, on Friday, and and

35:59

and that's so far to seek. So

36:02

I want to go back to the start

36:04

of our discussion and just talk

36:07

very very broadly about

36:09

the strength of the U. S. Treasury market

36:11

in terms of actual structure and

36:14

the plumbing. We've

36:16

seen these instances where liquidity

36:19

seems to evaporate, and you know,

36:21

last week wasn't necessarily as bad as what we

36:23

saw in March, but we did see bid ask

36:25

spreads on treasuries start to blow out. How

36:28

concerned are you about,

36:32

I guess the structure of the treasury market or

36:34

liquidity within the treasury market generally.

36:38

You know, I think I think it's a philosophical

36:41

question. I think, you know, markets

36:45

are not supposed to be about no

36:48

volatility at all. In

36:50

fact, I think is a is a

36:52

healthy phenomenon. And you know, I just don't

36:54

think moves that we have seen

36:57

last week. I mean, again, you know, markets

37:00

go from one extreme to another. But but for

37:02

as long as there is a you

37:04

know, mechanism whereby some value

37:07

based investory is going to provide an outside

37:09

spread and put a lid on things,

37:12

that's great. And I think, you know what,

37:14

what what I think happened less

37:16

weak is actually you know, I tend

37:18

to focus on, you know, the self healing

37:21

properties of the market, and from that perspective,

37:23

I think that the market work fine. It's

37:26

just that you know, some leveled players were

37:28

shaken out of their position because you

37:31

know, the market perception of

37:33

of how committed central banks or

37:36

two to keeping rates low has

37:39

has changed. And then you know, central banks basically

37:41

when the other way, and and and and the

37:43

market the market calm down, So

37:46

you know, I wouldn't point to you

37:48

know, there's too much regulation and that's why the

37:50

market is creating this way, or or

37:53

or any of that. I think. I think it's just it's just

37:55

a healthy development. I mean, it's

37:57

not comfortable, especially if you're on the wrong side

37:59

of trade. But I don't

38:02

think, but I don't think that that

38:05

we should be going um down

38:07

a path where, you know, we need to redesign

38:09

the treasury market because there is occasional basketball

38:12

activity in it. Well, Sultan,

38:14

I think that's a great place to leave

38:16

it, and we could always talk to you for

38:19

a few hours. Thank you so much for

38:21

coming on. We appreciate it. Thanks

38:23

that was really great. Thank you very much for having

38:26

me, guys, so

38:47

Joe. It's always great having Sultan on.

38:49

And his explanation of the price

38:51

action last week was probably the clearest

38:54

one that I've seen so far. And

38:56

you know, a lot of people were sort of freaking out about

38:59

this being a central bank miscommunication

39:02

or the taper tantrum re ducts,

39:04

but actually, like if anything, it

39:07

resembled a sort of technical shift

39:10

in positioning as levered players,

39:12

you know, rethought their bets. Yeah,

39:15

there's always a lot of when

39:17

rates move violently, you know, we can't

39:19

really help but ascribe some sort of deep

39:22

economic significance to them,

39:25

and people love narratives about

39:27

all the bond market is challenging the FED

39:29

or inflation or maybe something with fiscal

39:31

policy, and I guess that's always

39:34

there to some extent, and perhaps

39:36

um this sort of the difficulties

39:39

in communication that maybe the

39:42

the Antipodaean central banks have had

39:45

in New Zealand and Australia kicking

39:47

things off, they've had sort of problems

39:49

with communicating about their medium term

39:52

rate path. But in the end, like

39:54

when you have a bunch of people who are all levered

39:57

into sort of roughly the same positioning,

40:00

and you have these other clouds hanging over the market,

40:03

such as the questions about the SLR

40:05

that a long described you can just get

40:07

stuff. It doesn't always necessarily have to

40:10

have sort of meaning per se.

40:12

Right, It's sort of the the game

40:15

stop equivalent for the treasury market.

40:17

Sometimes things just happen, yeah,

40:20

and it doesn't necessarily mean no,

40:23

that's the decab I actually thought about it with respective

40:26

games stop it's like something sometimes

40:28

things just happened, and just in the same way everyone

40:30

was like, oh, this is class warfare or

40:32

this says something about T plus two. It's like, yeah,

40:34

but sometimes things just happened in market. Um,

40:39

what was I gonna say? Oh? Yeah. I also thought it was

40:41

great that Salton kind of I mean, just on the

40:43

point about the bond market challenging

40:46

the Fed, which was a narrative that

40:48

we saw come out in some commentary

40:50

next week. You know, the Fed can't control the bond

40:52

market. The bond vigilantes have returned

40:55

that sort of thing. I thought it was really interesting.

40:59

Um, that's old, and basically said that he

41:01

regretted writing last

41:03

week that the FED could do an operation Twist

41:06

or something like that to keep a cap

41:08

on bond deals. Like he

41:10

sort of admitted that he was caught up in the moment

41:13

and that things have changed. But

41:15

but that's like it's not something that you hear from

41:18

a lot of analysts necessarily

41:20

that sort of honesty. No, totally

41:22

right. And also this idea, it's like, look like,

41:24

bonds are not equities and they

41:26

do have, as he pointed out, this sort of

41:29

um natural curve

41:31

mechanism and we have gotten to the

41:33

point where there's steepness in

41:36

the curves such that for

41:38

foreign FECs hedged buyers

41:40

there is now value there. A new set

41:42

of bidders comes in. So you

41:44

know, with a cut, with a with game

41:47

stop, you can have an extremely

41:49

long period of time in

41:51

which the underlying in

41:53

which the value of the security is extremely

41:55

divorced from anything resembling

41:58

fundamentals. And it really seems much

42:00

harder to have that. It's why it's

42:02

hard to like really even imagine what like a

42:05

treasury bubble would mean, because

42:07

you do have these sort of natural

42:09

buyers that come in at certain levels. If

42:12

you get a disconnect, and disconnects

42:14

do happen between fundamentals

42:17

and raids very quickly,

42:19

Uh, new sources of money emerge

42:22

in one direction or another, and

42:24

you don't get the movie going on forever. I

42:26

just had a great idea for a

42:29

financial market novel, which would

42:31

be, you know, a scenario in which

42:33

Wall Street bets tries to take on

42:35

the treasury market and force a squeeze.

42:38

That'd be interesting. Twenty one trillion dollar

42:40

market versus creditors.

42:43

Maybe we should write a novel together. We've we've

42:45

never been able to come up with a good idea for a like

42:47

proper finance book together. Maybe the answer

42:49

is a novel. Let's just go the fiction route.

42:51

I'd be up for you. All right, okay,

42:55

this has been another episode of the All

42:57

Thoughts podcast. I'm Tracy Alloway. You

42:59

can follow me on Twitter at Tracy Halloway

43:02

and I'm Joe wi Isn't though. You can follow me on

43:04

Twitter at the Stalwart. Follow our

43:06

producer Laura Carlson on Twitter.

43:08

She's at Laura M. Carlson. Followed

43:11

the Bloomberg Ahead of podcast Francesca Levie

43:13

at Francesco Today, and check

43:15

out all of our podcasts at Bloomberg under

43:18

the handle at podcasts. Thanks

43:20

for listening.