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Spot Markets Live Transcript: 10/10/22

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Today’s Spot Markets live session is with Anjuli Davies, formerly of the Telegraph and Reuters, Davies’ last posting was as Senior City Editor for the Telegraph, moving there from her role as Acting Chief UK Financial Correspondent for Reuters.

Comments addressing audience statements are in bold.


Izabella Kaminska 10:58

…. Early birds in the house ….

How exciting. This is a first.

Anjuli Davies 10:58

Cath the worm…

Izabella Kaminska 10:58

Hello and welcome to Spot Markets Live, the weekly review of what’s moving markets, but… (hopefully) with insight.

It’s spot because, well, spot markets are traded for immediate delivery, just like this chat. 🙂

Today we’re joined by Anjuli Davies again….Hello Anjuli.

Anjuli Davies 10:59

Morning or should I say moring…

Izabella Kaminska 10:59

haha

Let’s start with the big news.

Anjuli Davies 10:59

The live version of this chat will only be available to Blind Spot and Betaville subscribers from now on.

Izabella Kaminska 10:59

Yeah, that. But also this:

The BoE pulled a fast one out of its hat on Monday morning and announced an extension to its previous Open Market Operation from mini-budget fiasco day.

But the big news in the announcement is buried in the detail.

Anjuli Davies 11:00

What does that mean?

Izabella Kaminska 11:00

Based on prelim conversations with those who know, there are three things going on here.

1) The OMOs look a tad more permanent than originally hoped for. This implies a precarious liquidity situation in the market, which obviously clashes with the tightening cycle.

Anjuli Davies 11:01

And? I thought that they didn’t even get the £5 billion take-up?

Izabella Kaminska 11:01

Yep. It had been looking good up until now.

But really, none of this should be surprising. I hate to quote myself but here’s my Bloomberg piece from August 31:

The world of “intraday” funding — i.e., cash borrowed during the day as opposed to overnight — remains highly dependent on excess liquidity from central banks, even as Federal Reserve officials move to accelerate the rateat which this is to be withdrawn over September and October. Once this de facto free liquidity is retracted, funding shortages could easily appear again, potentially toppling over into overnight and longer-term markets. If they do, market participants will have to come up with their own solution — or go cap in hand to the Fed and risk stigmatization.

Just replace Fed for BoE. Same applies.

But I digress.

Anjuli Davies 11:02

Yes, Cassandra. Okay, so?

Izabella Kaminska 11:02

Well, the other bit of the puzzle is that the BoE is extending the eligibility of the collateral institutions supporting LDI firms can pledge to include corporate bonds.

This suggests a fear of additional firesales.

Here’s the detail from the Bank about the expansion:

In light of market conditions, the range of Sterling Monetary Framework (SMF) eligible collateral is being expanded in relation to this facility only, with effect from this Market Notice, to include non-financial corporate bonds of credit quality broadly equivalent to Baa3/BBB- or above, in addition to existing SMF eligible collateral. The full set of eligibility criteria and haircuts for this facility can be found on the Bank’s website at Level C collateral securities and summary of haircuts, respectively. There are no other changes to SMF collateral eligibility.

The extension to BBB corporate non-financial debt is interesting as I had heard earlier that one of the issues was the LDI entities had a mismatch with USD BBB corp debt. But that may be a coincidence and it was never confirmed.

Anjuli Davies 11:03

And last?

Izabella Kaminska 11:03

Also worth noting that the Bank’s new permanent short-term repo facility “launched last week” and offers an unlimited amount of reserves at Bank Rate each Thursday (i.e. BoE rate announcement days)…

I hadn’t noticed the announcement last week, but further investigation reveals this market notice from the BoE on August 4.

Seems they were preempting some stress with the unwind of the Asset Purchase Facility.

As they explained in the motivation for the facility (my emphasis):

To ensure that short-term market interest rates remain close to Bank Rate as the level of sterling central bank reserves reduces, the Bank will launch a new short-term open market operation (OMO), the Short Term Repo (STR). This will commence at the same time as any APF gilt sales begin. The STR will sit alongside the Indexed Long Term Repo (ILTR) as an OMO under the Bank’s Sterling Monetary Framework (SMF).

The Bank intends that the STR should be used freely from the point of introduction, as a way for counterparties to access reserves as necessary. The PRA would judge use of the STR as routine participation in sterling money markets and intends that it should be seen as such by bank boards and overseas regulators.

Anjuli Davies 11:04

Does look like they were anticipating things could get hairy.

Izabella Kaminska 11:04

But the whole point of the facility was for it to be associated with APF sales, not sudden new purchases.

Though, perhaps if it really is an OMO, the gilts bought under the mini-budget fiasco programme the past couple of weeks will be the first in line to be sold. In which case you might need the facility around for that.

Then again, they’ve just extended those purchases. ? So perhaps not.

Anjuli Davies 11:05

And what about the pricing and the terms?

Izabella Kaminska 11:05

The new short-term facility is NOT CHEAP. If you dig into the details you realise it’s actually 15 basis points ABOVE the bank rate for a 7-day term.

The operational details can be found here:

The fees will be set at a flat rate of 15bps above Bank Rate.  The fee rate

will not increase with size of drawing.

Curious to know what the liquidity specialists in the rabble below think?

But feels to me like this is really ALL ABOUT THE SHORT-TERM REPO FACILITY.

The BoE seems to have set this up as its special weapon if and when markets have a wobble.

Here’s a nice diagram:

But this note from September 1 now feels a little hubristic:

As Section 3 below explains, the point at which reserves become scarce in this way is probably several years away, given the MPC’s initial pace of APF unwind. But commercial banks’ overall demand for reserves is highly uncertain. It will evolve in response to financial and economic conditions, and may also be influenced by the distribution of reserves across the system, or other features of market structure. It is therefore possible that reserves scarcity could arise much sooner than expected.

Anjuli Davies 11:07

Yup

Izabella Kaminska 11:07

Note the facility is unlimited.

“The facility will allow counterparties to borrow unlimited amounts of reserves for 7 days, against high quality Level A collateral, at Bank Rate. A Market Notice has been published today describing the facility’s key terms.

And that without it in place the Bank thought it wouldn’t be able to manage unwinds at all:

Without the STR, in order to maintain control of short-term market interest rates the MPC would have to reconsider APF unwind at the point that upwards pressure on market rates began to appear, whether or not that was optimal from a monetary policy perspective.

Anjuli Davies 11:08

Any rates specialists in the room? What do you think?

Izabella Kaminska11:08

Here’s another diagram about how it should all work in theory:

Anjuli Davies 11:08

Love the black mode charts…

Izabella Kaminska 11:08

Yeah, very funky

This ties into Zoltan Pozsar’s idea of the “lowest comfortable level of reserves”. This is the argument that central bankers can’t really predict the base level of surplus liquidity needed by the market until the market wobbles.

At the point that reserves reach the minimum desired level, banks will be able to meet their demand for reserves at Bank Rate through use of the STR. This will stabilise the quantity of reserves supplied to banks, while allowing the MPC to continue reducing the stock of assets held in the APF.

It’s a strained metaphor, but…

It’s a bit like having to descend down a steep snow-covered and slippery mountain and having someone with a rope above you prop you up every time you slip. Yes, the rope use “eases” the descent.

But the descent is still continuing. Or at least that was the hope.

Who knows now?

Anjuli Davies 11:09

And how’s the pound coping? I see Mr. Kwarteng has finally brought forward its fiscal plan announcement to…Halloween.  (rather than November 23rd)

Izabella Kaminska 11:10

That feels inauspicious.

Anjuli Davies 11:10

And also aren’t 30-year gilts widening again?

Izabella Kaminska 11:10

Well, unexpected things will happen. And I’m hearing from the market that things are pretty sensitive.

Here was the pound about 30 mins ago

(The normal free feeds went a bit berserk at that time)

But yeah, thoughts on this from the rabble are appreciated. Does feel significant but controlled significant (for now).

Anjuli Davies 11:12

@Mark I’d be interested to know what this means for the banks…

Izabella Kaminska 11:12

@Frederic I think the BoE may have done that too in 2008. But I could be mistaken. I know they have a special Gilt Facility though, which allows them to create phantom gilts if and when they’re needed. The Fed didn’t have that, which is why it needed to create the Term Securities Lending Facility to lend USTs into the collateral shortage they had inadvertently caused by offering liquidity facilities on secured terms at the peak of the GFC crisis.

As the crowd gathers their thoughts, should we have a quick look at wider markets? Anjuli you’ve been watching things…


Anjuli Davies 11:14

In stocks news…European equities are down across the board following the strong US jobs data on Friday. FTSE100 -0.83%, Euro Stoxx50 -0.60%. Over on the FTSE250, does anybody know what’s happening to FTSE 250 Indivior? It’s up 387% this morning…. It’s the Reckitt Benckiser spinoff that was embroiled in Opioid lawsuits in America. I can’t seem to find any news that might’ve sparked the rally…

Izabella Kaminska 11:14

I have to say, the free data feeds today are being a bit weird. I wonder if this is a real quote?

Any insight is much appreciated. Definitely feels off-market. (*It turned out to be a data issue.)

Anjuli Davies 11:14

Over on the FTSE100 DS Smith, the packaging company released some upbeat forecasts for full-year performance, and their shares shot up near 11%

Izabella Kaminska 11:15

Funnily enough, I got to visit a DS Smith recycling facility back in early 2020… and I was about to do a big piece about the whole recycling market and the negative rates in some recycled paper products, but then Covid hit, and I never revisited as I didn’t have time.

Anjuli Davies 11:16

Time to go back there…

Izabella Kaminska 11:16

I can safely report that recycling paper is now back in positive territory (via letsrecycle.com)

I guess that’s probably because the cost of recycling has gone up. Or maybe because you can burn it for fuel now?

Anjuli Davies 11:17

Do we want to talk about what’s going on in Ukraine this morning?

Izabella Kaminska 11:17

Yes, it looks bad. Dnieper hit and Lviv. So the tit-for-tat for the bridge hit seems to have started. Worrying.

Anjuli Davies 11:18

According to the ministry of defense so far today 83 missiles have been fired and 43 intercepted. They’ve hit residential areas and children’s playgrounds.

My Ukrainian lodger says fragments of an explosion have reached her home in Kyiv. Her parents have all had to rush to the basement of a hospital as explosions are going off all the time.

Izabella Kaminska 11:18

This is so tragic. Really indiscriminate.

And I guess it implies there is going to be escalation.

Anjuli Davies 11:19

Doesn’t sound great at the moment.  Belarus has now upped its support for Russia which could be significant.

Via Mary Ilyushina

@maryilyushina

Breaking: Belarus president Alexander Lukashenko and Vladimir Putin agreed to deploy a joint regional group of troops. Belarus allowed Russia to use its territory as a staging ground but claimed it’s not sending troops. May change now.

Also, Moldova has reported Russian aircraft flying over its territory

Izabella Kaminska 11:20

That implies geopolitical tensions are going up not down.

Before we look at energy markets…

should we talk about PayPal?

Anjuli Davies 11:21

Sounds like we should!

Izabella Kaminska 11:21

I wasn’t really keen on using PayPal for the Blind Spot, but some subscribers insisted. So I set it up. I have a small sum of £500 still in there as a result.

Here’s what’s been happening when I’ve tried to transfer it from Saturday onwards:

Anjuli Davies 11:22

Is this the potential face of the modern-day bank run…? The other day my Apple pay on my iPhone didn’t work and I felt stranded. I don’t even carry my card around anymore.

Izabella Kaminska 11:22

It is kind of impossible to tell the difference between a cyber attack and a potential liquidity crisis. (***important update*** while I did check to see if others were experiencing similar issues, and some were, further investigation seems to reveal that in my case that I wasn’t fully verified on my account. But it certainly doesn’t help to be faced with such an error message.)

Anjuli Davies 11:22

@Dario I’ve concluded it was the merchant’s fault, as it subsequently worked.

Izabella Kaminska 11:22

I’ve set out the bulk of the Paypal story here:

Eagle-eyed free speech advocates, already pissed off with what the payment companies are doing with respect to pulling accounts from those criticising more controversial elements of government policy, spotted that US payment provider had amended its acceptable use policy to include a warning that those found guilty of  “sending, posting, or publication of any messages, content, or materials” that “promote misinformation” or “present a risk to user safety or wellbeing” could be clipped $2500 by the provider.

Anjuli Davies 11:23

Talk about the confiscation of assets.

Izabella Kaminska 11:23

Whatever you think about free speech, a private company just arbitrarily deciding to engage in forfeiture seems wrong on many levels.

So a huge campaign started at the weekend to have everyone delete Paypal, and even former PayPal bosses David Marcus and Elon Musk (whose x.com was merged into what became PayPal) chimed in to support the movement.

Anjuli Davies 11:24

So is PayPal going to have a liquidity crisis?

Izabella Kaminska 11:24

Hard to say. Definitely, something’s going on.

What I can say is that I don’t like the way modern liquidity crises involve zero engagement from companies and a random error message or maintenance note on the website.

But in the last 24 hours, PayPal has reversed the decision, saying it had been added by error.

Anjuli Davies 11:25

That’s hilarious. Who accidentally slips such a thing into a legal document?

Izabella Kaminska 11:25

I know it’s absurd. The irony is corporate spin still doesn’t count as misinformation.

Anjuli Davies 11:25

Looks like the internet is fining them more than $2,500.

Izabella Kaminska 11:25

It’s a stock to watch at the US open at the very least.

The main thing to remember is that PayPal is a bit like a properly licensed Tether. It is in theory incredibly well funded and has reserves parked away somewhere for every dollar on deposit.

But… it also sometimes engages in parking some of those reserves in an investment portfolio with less liquid assets. It also doesn’t have access to Lender of Last Resort.

Will it be caught out? Does feel like something is going on.

But I doubt it’s a solvency issue.

That said if a lot of people start pulling money out of the platform its business model will be impacted no matter what.

Anjuli Davies 11:27

And it does look like they’re doing that, as ‘Delete PayPal’ is still trending.

Izabella Kaminska 11:27

One other point, I don’t think a lot of people realise that PayPal pays zero interest on customer balances, keeping the differential it earns on the sums for itself.

That was maybe acceptable in a zirp world, but not so much when rates are going up.

Anjuli Davies 11:27

Has anyone else been caught out in the PayPal stasis?

Izabella Kaminska 11:28

Yeah, would be good to know.

But we haven’t finished with the liquidity chat just yet…

Anjuli Davies 11:28

What else have you got for us?

Izabella Kaminska 11:28

This was out via zerohedge…

Anjuli Davies 11:29

What’s that all about?

Izabella Kaminska 11:30

So, I’m really delving into the depths of my GFC muscle memory… but I think it might be connected to a story that Tracy Alloway (now at Bloomberg, where she is continuing to be awesome) did a long time ago back.

It was from January 2011 to be specific.

It was about a sneaky accounting change that the Fed had undertaken to ensure it could no longer go bust in the event of a QE unwind.

The backstory was something like, usually, the Fed transfers all its profits to the US treasury, but since it was taking a big risk buying up mortgage securities there was a risk that losses might emerge.

Here’s the relevant chunk:

Earlier this month the central bank made a subtle change to its accounting methods. One that might make it impossible for the Fed to show capital losses. The timing of the move was probably not coincidental, either. The central bank announced the change just as the debate about its solvency, ability and credibility was really heating up. Especially the idea that the Fed might be unable to tighten policy as much as required when the economy recovers, since doing so could lead it to go bankrupt and then the US Treasury would have to step-in and recapitalise, thus potentially undermining the central bank’s independence.

The relevant accounting change info is here:

As Tracy explained:

Before the above accounting change, any unremitted earnings that were due from the Fed to the US Treasury would accrue in that ‘other capital’ account. Now however, they’ll be shown in a separate liability item called ‘interest on Federal Reserve notes due to US Treasury.’ So instead of any future Fed losses showing up as a reduction in Fed capital (‘other capital’) — they’ll now show up as negative interest due to the US Treasury. The Fed will still send most of its profits to the Treasury on a weekly basis, but will postpone remittances if the new line item becomes negative.

So I think that tells you what you need to know about that.

BUT THERE’S MORE….!

Anjuli Davies 11:32

Go on…

Izabella Kaminska 11:32

As you know, I like to keep an eye on USD Swap Line activity at the Fed.

I’m a little bit obsessive about it because I’ve always considered the swap line intervention of 2008 to be one of the most important of the extraordinary actions the Fed took at the time.

For a long time, I thought I was the only one to have this strange obsession. Nobody else seemed to care.

I thought I was going mad.

And then one day, maybe circa 2011 or something, I finally met Zoltan Pozsar.

He was already well known in the plumbing world but wasn’t quite the star analyst name he is now.

But I’ll never forget the meeting (though I’m sure he might).

It was at the Royal Exchange.

I think it was a breakfast thing. I may have ordered orange juice.

We sat at the little table just at the right when you come in.

Anjuli Davies 11:34

Oh gawd Izzy, this sounds like the beginning of a really bad airport novel.

Izabella Kaminska 11:34

What can I say, he had me as soon as he said “Swap Lines”.

Imagine the scene.

Zoltan didn’t have much time.

Had to go to another meeting soon.

I said: “I love your work, but what’s this stuff about swap lines?

And then he mumbled something like “yeah I do think that the most underappreciated Federal Reserve action of the crisis was the swap lines”…

And I was like:

YOU.

COMPLETE.

ME.

?

Anjuli Davies 11:36

Did you then say: “Show me the liquidity?”

Izabella Kaminska 11:36

Ha.

ZP as the Jerry McGuire of liquidity works for me. (Though purely on a mutual liquidity interest level).

Anjuli Davies 11:36

Oh Izzy, any opportunity to get Tom Cruise into this…

Izabella Kaminska 11:37

Here’s the latest from the NY Fed regarding swap lines:

As you can see, it’s NOT the British banks borrowing dollars at this stage. Ironically (since ZP is at Credit Suisse) it’s the Swiss saying:

Someone mentions below that Credit Suisse is up 10% today… But this is fake news.

Anjuli Davies 11:38

Incidentally Izzy your old shop has a piece up entitled “Are central banks going bankrupt?”

Izabella Kaminska 11:39

Ah, I haven’t read it yet. But I’m sure that’s what’s always been said about the ECB’s ELA activity — that it creates a negative equity situation at the central banks doing it.

That’s the link to the Alphaville piece

Expert du jour Toby Nangle features too.

Izabella Kaminska 11:42

I see it’s written by Robin.

But yeah, the background is basically Tracy’s story from 2011.

And since he doesn’t refer to it, maybe he doesn’t appreciate the accounting issue.

(Also between us here on the chat, there’s a bit of a ██████████ and ██████████ rivalry)

So the prospect of negative equity has always plagued the ECB, and now the SNB now too. (By some measures I think the ECB is already well on its way.)

@mark – big fan of Aitken’s. And FYI, he’s already issued a promissory note to me that he will do a Leaked (very liquid) Lunch with me as soon as our diaries allow.

We just need to pick a venue.

I’m thinking somewhere near the BoE.

It won’t be as high drama as my Zoltan encounter tho 🙂 I probably won’t order orange juice.

Anjuli Davies 11:46

“high drama”

Izabella Kaminska 11:46

Btw – I think INvidior was a feed issue.

Anjuli Davies 11:46

Must be, since still no RNS out

Izabella Kaminska 11:47

Yeah, makes sense.

Just on the topic of cbanks going bust. It’s worth pointing out they are in almost all cases backstopped by the government, which means any negative equity they generate is always going to be transferred to the government balance sheet. If that’s the case, what it really means if it continues in size (especially if the governments can’t balance their own budgets) is that the money printing that was sterilised from 2008 onwards might not be so sterlised anymore.

I think that’s the best way to think of it. Though interested if anyone disagrees.

@robert – yes, I’ve always liked Willem Buiter on this. But I did spot that Anne Sibert was saying she thought the BoE interventions now amount to QE.

@thanks Colin

Izabella Kaminska 11:54

@bruce – I think we’re talking about central banks though.

Anjuli Davies 11:54

What’s the collateral situation?

Izabella Kaminska 11:55

Yeah, glad you mentioned that. I think this story from Reuters is also worth keeping an eye on.

  LONDON, Oct 6 (Reuters) – The collateral against

potential losses posted on derivatives trades at Eurex has risen

to a record high of around 130 billion euros ($128 billion) in

the face of highly volatile markets and stubborn inflation, Erik

Mueller, CEO of Eurex Clearing, told Reuters on Thursday.

This is up from around 100 billion euros needed during the

COVID-19 outbreak that wreaked havoc on world markets in early

2020. Mueller told Reuters that risk models at Eurex Clearing

suggested that the current environment meant there was a greater

need to bolster liquidity.

He added that roughly 40% of the total requirement is due to

use of interest rate swaps, up from a fraction during the

COVID-crisis in 2020.

Volatility means more initial margin. More initial margin means more demand for collateral. Which then absorbs all the collateral into the clearing system.

Anjuli Davies 11:56

Do platforms like Eurex get to repo their collateral?

Izabella Kaminska 11:57

That is a good question. I actually don’t know. But I do know that people like Manmohan Singh have long been arguing that the cbanks should repo out their asset purchases back into the market to help with collateral velocity. But I guess it should apply to clearers too.

Anjuli Davies 11:58

On that note, we’re nearly out of time

Someone pointed this out to us though earlier

@WallStreetSilv

7h

Police in France are now checking your fuel tank before they allow you access to petrol stations… if you have too much in your tank, you are turned away. Shortages in France are forcing people to wait in lines for hours to get only a partial refill of fuel.

Izabella Kaminska 11:59

This is quite extraordinary. There’s a video that goes with it.

Anjuli Davies 11:59

Is this where we are all headed, along with blackouts? Izzy, have you got candles and torches at the ready?

Izabella Kaminska 12:00

All I can say is that I received a note from my property management service… yes, yes… I have access to a bolt-hole in the French alps from back in the day when I was based in Geneva… that there is absolutely no wood to be had anywhere in the valley.

I don’t just have torches and Candles, Anjuli. As a dedicated countercyclical prepper, I have one of these.

Anjuli Davies 12:01

Didn’t even know these existed…

Izabella Kaminska 12:01

Well, I was considering getting an accompanying solar panel, but what I figured was that actually, the main problem was going to be blackouts, so as long as you can drain the energy into a battery while it’s available that’s all that really matters.

My main concern is about the fridge.

Anjuli Davies 12:03

Well in winter, you’ll be fine – and in Chamonix, you’ve got snow

Izabella Kaminska 12:03

And on that note, it’s a wrap. Just a quick reminder that since the live sessions are now behind paywall, if you want in and already have a subscription just fill out this form using the same email that is attached to your subscription. If you don’t have a sub, all you need to do is take out the basic one (not the premium) and then apply in the same way. If you have a Betaville subscription, the same applies. Everything is processed manually, so don’t get mad if you don’t have an automatic confirmation. But we will definitely process everything before the next session.

I’m away at Bitcoin Amsterdam this Wednesday speaking on a panel about the problem with crypto media with my former partner in chart crime Jemima Kelly, of the FT.

If markets get hairy and we need an impromptu session I will advertise on Twitter, Discord, Linkedin and TBS.

For now it’s bye from me.

Anjuli Davies

And bye from me.

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