Reverse repo musings - US market suspicions
Discussion
As I understand, funds, PE businesses and the like are swapping their cash in exchange for govt bonds, which we all know is a terrible yield, certainly given US inflation is nearer 4%, but I understand this to be normal practice to balance liabilities against what they're investing in equities?
The musings I've been reading are around the rate and amounts that are snowballing into this area. The graph below shows recent trend of 200bn increasing to 1.3tn within a couple of months, breaking records on the daily.
I must admit I don't know a lot about this. It could simply correlate to the companies making X in the equity market and logically continue to balance - but at this rate? I wondered what people's thoughts were? Internet tosh or something to think about?
The musings I've been reading are around the rate and amounts that are snowballing into this area. The graph below shows recent trend of 200bn increasing to 1.3tn within a couple of months, breaking records on the daily.
I must admit I don't know a lot about this. It could simply correlate to the companies making X in the equity market and logically continue to balance - but at this rate? I wondered what people's thoughts were? Internet tosh or something to think about?
Quite interesting article musing on bonds here:
https://www.forbes.com/sites/georgecalhoun/2021/07...
“A complex balance of forces is at play in the market for U.S. Treasury debt. An increase in bond yields for the right reasons – a recovery in economic activity, a tighter labor market, and a modest increase in expectations of wage and price inflation – would not be such a bad thing… In contrast, an increase in bond yields attributable to rising concerns about the level of debt and a possible surge in inflation without a strong recovery would be harmful… The trouble is that these two outcomes are observationally equivalent in the short run.”
https://www.forbes.com/sites/georgecalhoun/2021/07...
“A complex balance of forces is at play in the market for U.S. Treasury debt. An increase in bond yields for the right reasons – a recovery in economic activity, a tighter labor market, and a modest increase in expectations of wage and price inflation – would not be such a bad thing… In contrast, an increase in bond yields attributable to rising concerns about the level of debt and a possible surge in inflation without a strong recovery would be harmful… The trouble is that these two outcomes are observationally equivalent in the short run.”
AIUI? (I probably don’t 
)
Treasury General Account (TGA) at Federal Reserve being drawn down and excess liquidity generated being hoovered up by reverse repos?
https://wolfstreet.com/2021/08/15/the-wolf-street-...
)Treasury General Account (TGA) at Federal Reserve being drawn down and excess liquidity generated being hoovered up by reverse repos?
https://wolfstreet.com/2021/08/15/the-wolf-street-...
https://www.investopedia.com/terms/r/reverserepurc...
I think I'm getting old as I need to re-read things to even begin to understand the next phrase that I need to go and google and re-read and then google in an endless loop of banking jargon.........I'm not sure it's good what's happening but will us plebs on the street eventually feel it somehow?
One line says "Reverse repos are commonly used by businesses like lending institutions or investors to lend short-term capital to other businesses during cash flow issues" so perhaps supporting zombie companies en masse is happening/required.
I think I'm getting old as I need to re-read things to even begin to understand the next phrase that I need to go and google and re-read and then google in an endless loop of banking jargon.........I'm not sure it's good what's happening but will us plebs on the street eventually feel it somehow?
One line says "Reverse repos are commonly used by businesses like lending institutions or investors to lend short-term capital to other businesses during cash flow issues" so perhaps supporting zombie companies en masse is happening/required.
Scootersp said:
https://www.investopedia.com/terms/r/reverserepurc...
I think I'm getting old as I need to re-read things to even begin to understand the next phrase that I need to go and google and re-read and then google in an endless loop of banking jargon.........I'm not sure it's good what's happening but will us plebs on the street eventually feel it somehow?
One line says "Reverse repos are commonly used by businesses like lending institutions or investors to lend short-term capital to other businesses during cash flow issues" so perhaps supporting zombie companies en masse is happening/required.
This might help…. I think I'm getting old as I need to re-read things to even begin to understand the next phrase that I need to go and google and re-read and then google in an endless loop of banking jargon.........I'm not sure it's good what's happening but will us plebs on the street eventually feel it somehow?
One line says "Reverse repos are commonly used by businesses like lending institutions or investors to lend short-term capital to other businesses during cash flow issues" so perhaps supporting zombie companies en masse is happening/required.
https://m.youtube.com/watch?v=qEgpPJgaJng
Banks increasing Reverse Repo is a logical extension of expansive monetary policy. They cannot give it away fast enough, so what you cannot lend to punters; sorry the real economy you are better of financing someone elses business (or back to the central bank). No one does unsecured financing "wholesale" anymore as post crisis regulations killed that. In Europe, the ECB pumped so much money into the system, they have to subsidise the banks with tiering when they take it back.
Repo is one of the main funding / balance sheet / leverage creation tools banks use.
The scale is f
king monumental. 2 of us run a Repo / financing book with a gross size of EUR150billion at a bank; but as the OP says it's a funding / liability management tool, it collapses in on itself.
Since 2008 it's very, very difficult to get stimulus into the economy. Post crisis regulations and expansion monetary policy fight each other. A lot of the rate (lowering) benefit gets eaten by transmission loss (bank cost / profiteering). Repo eats a lot of balance sheet, which has to be covered by Capital (Supplemental Leverage Ratio), look it up. It creates the dumbest regulatory arbitrage of all time (despite the G20 agreeing Basel3, no one calibrated it the same); which "may" end up being the next biggest scandal if a bank blows up.
Repo is one of the main funding / balance sheet / leverage creation tools banks use.
The scale is f
king monumental. 2 of us run a Repo / financing book with a gross size of EUR150billion at a bank; but as the OP says it's a funding / liability management tool, it collapses in on itself. Since 2008 it's very, very difficult to get stimulus into the economy. Post crisis regulations and expansion monetary policy fight each other. A lot of the rate (lowering) benefit gets eaten by transmission loss (bank cost / profiteering). Repo eats a lot of balance sheet, which has to be covered by Capital (Supplemental Leverage Ratio), look it up. It creates the dumbest regulatory arbitrage of all time (despite the G20 agreeing Basel3, no one calibrated it the same); which "may" end up being the next biggest scandal if a bank blows up.
Edited by stongle on Wednesday 25th August 09:55
Edited by stongle on Wednesday 25th August 09:57
What's interesting is people like Stongle, live this and a few of us try to understand parts of this and what 99.9% of people have no clue at all beyond, the basics.
So layers and layers of debt and refinancing and 'instruments' which mean nothing to most but are essential to maintain the system everyone uses is that the short of it?
So layers and layers of debt and refinancing and 'instruments' which mean nothing to most but are essential to maintain the system everyone uses is that the short of it?
stongle said:
Since 2008 it's very, very difficult to get stimulus into the economy.
And diminishing returns as they try/do?Edited by stongle on Wednesday 25th August 09:55
Edited by stongle on Wednesday 25th August 09:57
https://www.dlacalle.com/en/us-disappointing-growt...
Scootersp said:
What's interesting is people like Stongle, live this and a few of us try to understand parts of this and what 99.9% of people have no clue at all beyond, the basics.
So layers and layers of debt and refinancing and 'instruments' which mean nothing to most but are essential to maintain the system everyone uses is that the short of it?
Pretty much. So layers and layers of debt and refinancing and 'instruments' which mean nothing to most but are essential to maintain the system everyone uses is that the short of it?
A bank does 2 things. Provide leverage (credit) and maturity transformation. Anything else is secondary. Repo allows you to generate huge amounts of leverage. Providing banking is a loss leader, custody of assets requires secondary services to be sold.
A hedge fund who wants to bet on "upside" of a stock or sector, uses leverage (from a bank) to generate mega returns.
The bank effectively provides a derivative (option, CFD or simply margin product to generate the uppside). The client pays the margin, but the bank HAS to hedge its risk. It hedges those derivatives sold by buying the underlying assets (so is delta or market risk neutral), but rehyothecates those assets to fund its books by repo (type) products.
It's building leverage, you can take a small amount of stimulus from a central bank and spin it up dozens of times. That's why equities can do 500% growth in 5 or 6 years. It's layers upon layers off financing pushing leverage into the system.
Scootersp said:
stongle said:
Since 2008 it's very, very difficult to get stimulus into the economy.
And diminishing returns as they try/do?Edited by stongle on Wednesday 25th August 09:55
Edited by stongle on Wednesday 25th August 09:57
https://www.dlacalle.com/en/us-disappointing-growt...
After several decades of MP replacing fiscal stimulus and lowish wage growth, they are passing the baton back.
Scootersp said:
Thanks.......So banks have too much money they can't lend but can get a tiny bit of interest from the FED by reverse repo'ing daily so far more are doing this?
ThisBanks may have excess liquidity (customers saving money over past year therefore cash savings increasing, loans being repaid but banks term funding not early repaid.
Excess cash managed daily with reverse repos. Better rates than depositing with Fed/BoE etc.
Can’t buy back certain types of bond issuance as it may count towards capital (minimum amounts in issuance required).
Also, additional cheap funding from TFSME adding to surplus cash.
Look to Danish (i think bank) that offered negative interest rate mortgages - cheaper than putting cash on deposit with ECB.
Flipside, banks will need to find a way to make money therefore bank charges will become more of the norm and an end to free banking, methinks
Langleyuser said:
And how does this, impact mortgage rates and equity markets ? More specifically in UK ..
Could lead to lower mortgage rates. Positive rates are better than negative returns on ECB.Also depends on swap rates too as banks fund floating rate bu typically lend to consumers on a fixed rate so swap rates show what market is pricing in for future rate rises
Scootersp / B9 (replying to both on the leverage risk question),
The risk is "too big to fail" hasn't gone away, its arguably a bigger risk today than in 2008.
If you look at S&P500, it's valuation today is around $38trillion (mkt cap), up over 400% since 2008. That's probably $25trillion+ in growth, but the Fed ONLY increased its balance sheet by 7-8trillion in the same period. Additional leverage is coming into the system. A lot of it.
By using repo, you can build a balance sheet as follows (this is a very basic example, you'll actually run into several regulatory costs / ratio's - but you'd get around that with repo like derivatives); but in short you'd do something like this:
Value Refinance Cash In Haircut
Buy UST Bonds 1000000 Repo 1000000 0%
Buy AAPL SHS 1000000 Repo 950000 5%
Buy AAPL SHS 950000 Repo 902500 5%
Buy AAPL SHS 902500 Repo 857375 5%
Buy AAPL SHS 857375 Repo 814506.25 5%
Buy AAPL SHS 814506.25 Repo 773780.9375 5%
Buy AAPL SHS 773780.9375 Repo 735091.8906 5%
Buy AAPL SHS 735091.8906 Repo 698337.2961 5%
Buy AAPL SHS 698337.2961 Repo 663420.4313 5%
Buy AAPL SHS 663420.4313 Repo 630249.4097 5%
Buy AAPL SHS 630249.4097 Repo 598736.9392 5%
Buy AAPL SHS 598736.9392 Repo 568800.0923 5%
Buy AAPL SHS 568800.0923 Repo 540360.0877 5%
Buy AAPL SHS 540360.0877 Repo 513342.0833 5%
Buy AAPL SHS 513342.0833 Repo 487674.9791 5%
Buy AAPL SHS 487674.9791 Repo 463291.2302 5%
Buy AAPL SHS 463291.2302 Repo 440126.6687 5%
Buy AAPL SHS 440126.6687 Repo 418120.3352 5%
Buy AAPL SHS 418120.3352 Repo 397214.3185 5%
Buy AAPL SHS 397214.3185 Repo 377353.6025 5%
Buy AAPL SHS 377353.6025 Repo 358485.9224 5%
Buy AAPL SHS 358485.9224 Repo 340561.6263 5%
Buy AAPL SHS 340561.6263 Repo 323533.545 5%
Buy AAPL SHS 323533.545 Repo 307356.8677 5%
Buy AAPL SHS 307356.8677 Repo 291989.0243 5%
Starting with 1m UST, you could lend them to raise cash, invest in AAPL (Apple Inc) and then keep refinancing the AAPL shares to raise more cash ONLY running out of room when the haircut bleeds you out. 25 cycles, gets you a balance sheet of $16m.
Its entirely private sector leverage creation, and its critical in understanding asset price growth. There is a huge delta between what the Central Banks can do, and what the private sector can (it also fits well into MMT theory). The leverage creation is really only limited by running out of haircut and regulatory resource "containment". To try and limit private sector leverage growth, the G20 *via BASEL regs); introduced ratio's of Capital to Balance Sheet size. This is designed to limit excessive leverage growth by ensuring enough loss absorption buffer exists. Capital costs, so it adds profit drag OR has to be passed through to the end user of credit.
Assuming a 3% Leverage ratio (or capital buffer); you are adding around 45bps of cost (0.45%) to any "on balance sheet" loan. If rates go negative (at Central Bank); its very rare the banks can pass through as they have to cover their own and regulatory costs. Its worse for banks, as often they cannot pass negative rates through to depositors - so they eat the loss (big issue in Europe). Its why as above poster points out deposit charging is coming.
Obviously there is a lot you can engineer to shrink balance sheet, risk (costs) etc; but it is ALL leverage creation in the private sector. Bank / Non-Bank. With all the leverage being collateral backed, contagion / firesale risk is immense. If a large bank goes into default, anyone who has lent them money (Vs collateral) wants to sell it quick to get their money back. Everyone hits sale at the same time, so velocity is critical. If you have a book (above example) built on 25, 30, 50 times leverage; and you're collateral (AAPL SHS) is in free fall - you get margin called to death (you have to post cash other assets to make up the shortfall Vs the loan amount).
These markets work on the assumption that they are always liquid, or the Central Banks will step into provide liquidity. The Fed has to do this often, as the market DOES dry up cash around Tax payment dates or debt rollovers. Suddenly you will see the Fed pumping billions into the market to stop repo lending rates going into orbit (which are very simply a supply of cash reflection).
That's perhaps a long post, but its only scratching the surface of process and risks. It IS using a lot of brevity, so worthwhile doing your own research.
The risk is "too big to fail" hasn't gone away, its arguably a bigger risk today than in 2008.
If you look at S&P500, it's valuation today is around $38trillion (mkt cap), up over 400% since 2008. That's probably $25trillion+ in growth, but the Fed ONLY increased its balance sheet by 7-8trillion in the same period. Additional leverage is coming into the system. A lot of it.
By using repo, you can build a balance sheet as follows (this is a very basic example, you'll actually run into several regulatory costs / ratio's - but you'd get around that with repo like derivatives); but in short you'd do something like this:
Value Refinance Cash In Haircut
Buy UST Bonds 1000000 Repo 1000000 0%
Buy AAPL SHS 1000000 Repo 950000 5%
Buy AAPL SHS 950000 Repo 902500 5%
Buy AAPL SHS 902500 Repo 857375 5%
Buy AAPL SHS 857375 Repo 814506.25 5%
Buy AAPL SHS 814506.25 Repo 773780.9375 5%
Buy AAPL SHS 773780.9375 Repo 735091.8906 5%
Buy AAPL SHS 735091.8906 Repo 698337.2961 5%
Buy AAPL SHS 698337.2961 Repo 663420.4313 5%
Buy AAPL SHS 663420.4313 Repo 630249.4097 5%
Buy AAPL SHS 630249.4097 Repo 598736.9392 5%
Buy AAPL SHS 598736.9392 Repo 568800.0923 5%
Buy AAPL SHS 568800.0923 Repo 540360.0877 5%
Buy AAPL SHS 540360.0877 Repo 513342.0833 5%
Buy AAPL SHS 513342.0833 Repo 487674.9791 5%
Buy AAPL SHS 487674.9791 Repo 463291.2302 5%
Buy AAPL SHS 463291.2302 Repo 440126.6687 5%
Buy AAPL SHS 440126.6687 Repo 418120.3352 5%
Buy AAPL SHS 418120.3352 Repo 397214.3185 5%
Buy AAPL SHS 397214.3185 Repo 377353.6025 5%
Buy AAPL SHS 377353.6025 Repo 358485.9224 5%
Buy AAPL SHS 358485.9224 Repo 340561.6263 5%
Buy AAPL SHS 340561.6263 Repo 323533.545 5%
Buy AAPL SHS 323533.545 Repo 307356.8677 5%
Buy AAPL SHS 307356.8677 Repo 291989.0243 5%
Starting with 1m UST, you could lend them to raise cash, invest in AAPL (Apple Inc) and then keep refinancing the AAPL shares to raise more cash ONLY running out of room when the haircut bleeds you out. 25 cycles, gets you a balance sheet of $16m.
Its entirely private sector leverage creation, and its critical in understanding asset price growth. There is a huge delta between what the Central Banks can do, and what the private sector can (it also fits well into MMT theory). The leverage creation is really only limited by running out of haircut and regulatory resource "containment". To try and limit private sector leverage growth, the G20 *via BASEL regs); introduced ratio's of Capital to Balance Sheet size. This is designed to limit excessive leverage growth by ensuring enough loss absorption buffer exists. Capital costs, so it adds profit drag OR has to be passed through to the end user of credit.
Assuming a 3% Leverage ratio (or capital buffer); you are adding around 45bps of cost (0.45%) to any "on balance sheet" loan. If rates go negative (at Central Bank); its very rare the banks can pass through as they have to cover their own and regulatory costs. Its worse for banks, as often they cannot pass negative rates through to depositors - so they eat the loss (big issue in Europe). Its why as above poster points out deposit charging is coming.
Obviously there is a lot you can engineer to shrink balance sheet, risk (costs) etc; but it is ALL leverage creation in the private sector. Bank / Non-Bank. With all the leverage being collateral backed, contagion / firesale risk is immense. If a large bank goes into default, anyone who has lent them money (Vs collateral) wants to sell it quick to get their money back. Everyone hits sale at the same time, so velocity is critical. If you have a book (above example) built on 25, 30, 50 times leverage; and you're collateral (AAPL SHS) is in free fall - you get margin called to death (you have to post cash other assets to make up the shortfall Vs the loan amount).
These markets work on the assumption that they are always liquid, or the Central Banks will step into provide liquidity. The Fed has to do this often, as the market DOES dry up cash around Tax payment dates or debt rollovers. Suddenly you will see the Fed pumping billions into the market to stop repo lending rates going into orbit (which are very simply a supply of cash reflection).
That's perhaps a long post, but its only scratching the surface of process and risks. It IS using a lot of brevity, so worthwhile doing your own research.
Federal Reserve reverse repo now touching $2tn (!):
https://www.reuters.com/markets/us/record-us-rever...
And US inflation officially at 8%+ (but likely double):
http://www.shadowstats.com/alternate_data/inflatio...
Things are going, er, well? lol
https://www.reuters.com/markets/us/record-us-rever...
And US inflation officially at 8%+ (but likely double):
http://www.shadowstats.com/alternate_data/inflatio...
Things are going, er, well? lol
RRPs, AIUI (possibly still don't), are a mechanism to stop borrowing rates falling.
This issue is symptomatic of too much liquidity in the system.
As I posted earlier, Wolf Richter does a good analysis on this.
https://wolfstreet.com/2021/12/31/fed-drains-1-9-t...
Read, try and understand.
This issue is symptomatic of too much liquidity in the system.
As I posted earlier, Wolf Richter does a good analysis on this.
https://wolfstreet.com/2021/12/31/fed-drains-1-9-t...
Read, try and understand.
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