personal views of a former fed trader

Tag: Basel III

The Elasticity of 5 Basis Points

Large money market investors will move billions for even a basis point. A 5bps increase to the RRP offering rate led to a $200b+ surge in participation, but there is a wrinkle to the story. The bulk of the increase likely came from Government Sponsored Enterprises (“GSEs”) who were leaving hundreds of billions at 0% in their Fed account, so it was not an incremental flow from the private sector. That being said, the 5bps increase puts money market funds (“MMFs”) in a position to offer their investors a few basis points in yield. This will make it easier for banks to continue to push out their high cost deposits. The departed deposits will quickly be replaced by the constant flow of low cost deposits created from Fed financed deficit spending. In this post we shed light behind this week’s RRP surge, the improving funding profiles of banks, and why this means FRA-OIS will continue to narrow.

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The Gravitational Pull of Zero

GSIB High Quality Liquidity Asset (“HQLA”) portfolios are a mechanism through which low rates in the front-end are exerting downward pressure on longer dated yields. Fed QE has filled bank balance sheets with low yielding reserves, and deprived non-banks of any yield at all in the front-end. An unconstrained investor can escape 0% yields by moving along the risk curve to Bitcoin, but GSIBs are confined by Basel III to the most prosaic investments. GSIBs have both limited balance sheet space and HQLA requirements, so they are optimizing their portfolio by exchanging 0.1% yielding reserves for Treasures. Over the past year they have purchased $350b in Treasuries, tilted towards longer dated maturities. In this post we review why GSIBs are purchasing Treasuries and illustrate the scale and maturity profile of those holdings based on recent regulatory filings.

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Why Are Banks Issuing So Much Debt?

U.S. GSIBs recently issued a torrent of debt, with record breaking issuance sizes from JPM and then BAC. Yet, at the same time we know that the banking system has too much liquidity, and that banks are pushing out poor quality deposits to money market funds, who ultimately pour the excess liquidity down the ON RRP drain. The two behaviors can be reconciled by understanding the very strong regulatory incentives put on GSIBs to issue longer term liabilities. In response to the Financial Crisis, regulators devised a set of complementary regulations (Basel III) aimed at preventing future bank runs by setting limits on the size and composition of their balance sheets. Unsecured long term debt is favorably treated under all those constraints, and is especially compelling at near record low yields. We have already discussed how the Liquidity Coverage Ratio encourages longer term debt issuance. In this post we review the what and why of a few more Basel III constraints: the Net Stable Funding Ratio, GSIB Short-Term Wholesale Funding Indicator, and Total Loss Absorbing Capacity.

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