De-xia Vu

Wednesday, December 14, 2011

Something has been bugging TMM for a couple of weeks. Various bits of the market have been behaving in odd ways, that could have many different explanations in isolation. But when seen together, TMM reckon they have figured out what is going on.

First, as readers will know, the recent explosion of CVA desks, one-way CSAs and the like have resulted in large, relatively price-insensitve flows in many markets - but particularly in Euro 10s30s (see below chart). At first, TMM thought the recent sharp flattening was merely more of the same. But yesterday an unwind of a large and old asset swap drove 10s30s to the flattest it has been since 2008. This is very unusual behaviour for December when liquidity is not great.

Second, despite the very large take-up in the now very cheap Fed/ECB 3m $ Swap Facility last week, the 3m EURUSD Basis has rewidened (see below chart). As readers will know, TMM are of the opinion that the USD funding crisis is overhyped, but the new attractive terms have encouraged substitution from French banks (who issue their own USD CP in the US). As TMM's mates in the FX Forward market point out, there are still many smaller banks that are unable to access the Swap Facility due to a lack of collateral. Additionally, TMM remember from their old days working at investment banks that at year end, European real money - in particular Dutch pension funds - tend to do quite a lot of funding of their foreign assets via the FX Forward market. Again, at a time when liquidity in the FX Forward market is diminished due to most banks now either funding directly in the US or via the Swap line, this has not helped things, and when dealers have put on basis tighteners post the $ auction (catching them out). But it still does not completely explain why there has been pressure across the FX Forward curve. It seems that at least one bank has been somewhat price insensitive.

Third, even funding markets in places with relatively strong banking systems like Japan and Sweden have seen FRA-OIS basis widening (see chart below of Swedish FRA-OIS basis).

Fourth, usage of the ECB's Marginal Lending Facilty (see chart below) has spiked over the past few weeks. In the absense of other information, markets would not be incorrect in concluding that "something is very wrong"/"a bank is in trouble".

Now, TMM have scratched their collective heads, and suggest the following as an explanation...

TMM would ask readers to cast their minds back to February. Usage of the ECB's Marginal Lending Facility spiked (see the above chart), and it soon became clear that this was related to the winding down of the Irish banks and their transition to ELA funding. With the restructuring imminent, the usage of the ECB's lending facility turned out merely to be a stop gap until everything was in place for the transition.

The reason TMM bring this up, is that the splitting and wind down of Dexia - announced a couple of months ago - is of a completely different magnitude to that of the Irish banks. Dexia's balance sheet only recently still sat at over EUR 400bn (see below chart), and has quite large international exposures. It doesn't take too much to make the intellectual leap that a bank that is in the process of being split in two and wound down, that is quite big internationally, might have quite a large amount of international hedging/cleaning to do (which would explain a good chunk of both the cross-currency and FRA-OIS basis move). Dexia was also the rumoured counterparty unwinding the above mentioned asset swap at not-particularly-price sensitive levels. And given the bank was well-known to be having funding problems, but whose restructuring is imminent, it would not be a surprise to TMM if that ECB lending facility usage was in fact Dexia, as a stop-gap until its restructuring is completed. It is worth noting that when Depfa was wound down, Dexia's "sister" institution never had to go through this process, as it's a bad bank wholly owned by the Germans (FMS Wertmanagement now), who don't really have their own funding issues.

This is all speculation, but TMM reckon the latest market basis/funding worries could very well merely be part of Dexia's pre-restructuring clean up of the books ready for split-up and wind down. In which case, the deposit facility usage should soon come down, and perceived funding stresses roll-off.


If this post helped you, please help them. TMM's Xmas Charity Appeal:

Posted by cpmppi at 9:46 AM  


TMM, Are we not approaching extreme "talk your book"/"grasping at straws"-levels on this blog now?

Anonymous said...
10:55 AM  

Well I for one am grateful to TMM for pointing out something other than the lemming mantra of apocalypse. As for talking their books.. I hope they are. The only folks I know who are stupid enough to talk an idea in contradiction to their own possies are i.b. junk sales desks. I don't know how big tmm's books are but doubt they are in need of a fluffing to exit.

So TMM, your opinions may not be in line with "market" and the vehemence of response is in itself very telling. But that's why I read you.

And finally.. whatever you write is going to be better reasoned than the response from anon above! Thank you.

Anonymous said...
11:22 AM  

imho... a trader who does not talk his book should not be running one in the first place...

Anonymous said...
11:48 AM  

'Talking your book' doesn't mean expounding the intellectual underpinnings of one's own trades...after all, as pointed out, you'd have to be an idiot / schizophrenic to do it any other way, except as a Platonic exercise.

Rather, 'talking yr book', in the pejorative sense, refers to fluffing up some dog in the hope of laying it off to freshly horned-up punters at favourable levels...penny-stock, pump-and-dump, IB, Pimpco stylee.

This distinction seems to confuse some commentators.

VandalsStoleMyHandle said...
12:35 PM  

BTW, good stuff today; food for thought.

VandalsStoleMyHandle said...
12:35 PM  

You may be correct,or you might not be,but to be honest I think the market flow has moved past this stuff for the moment anyway.

The currency trends now developing suggest different concerns ,or that is my, not very profound, insight.

Anonymous said...
12:48 PM  

Great post.

1:39 PM  

On the one hand, I can see that this explanation could be seen as somewhat benign.

But doesn't it beg the question of what happens when if the larger banks get in trouble? Have any of the EU initiatives addressed the fact that all their largest banks would be insolvent if they had to correctly value the soveriegn debt they hold?

Bob_in_MA said...
2:12 PM  

interesting post TMM, I think this sheds to light the importance of the bank funding market. Most equity guys dont have a clue about this stuff. Traders are starting to pay attention to it, but dont really know what drives it, and the people who really understand it still dont have a clear grasp on all the moving parts. But thanks for your take

abee crombie said...
2:30 PM  

Excellent analysis, especially paying attention to "price insensitivity".

We tend to agree that pressure on the equity markets will be relieved before long, at least for a relief rally. If EURUSD is ever going to find support, then right here around the level of the January lows would be logical. Failure to hold this level would ring a few alarm bells and might intensify short-term funding concerns. One would therefore expect the FX swap lines to be active today. Hence not a bad place for a punt from the long side?

However, if we agree that QE3 will be a March 2012 event (or later) then it follows from the DXY chart that there are now strong support levels in place for USD just below DXY 80 and around DXY 78. This provides additional support for the bearish arguments regarding commodities in 1H 2012. This means that commodity rallies will all be sharp squeezes, and equities will probably reflect that.

The Norwegian rate cut (by 50 bps) clearly reflects some concern around Europe that a sharp slowdown is already in progress, and this from an oil producer, we would add.

Leftback said...
3:06 PM  

Bugs On The Windscreen this week, TMM. Gold fans taking it up the Gary.

(Go on, use that as a post title and watch the comment-o-meter rocket).

All That Glitters

Saul Bollox said...
3:22 PM  

Thats not a good idea,Saul.TMM charity is only a couple hundred bucks from the finish line :)

ps..weekend meetings?

Amplitudeinthehouse said...
7:23 PM  

Good point, Ampo. Righto, then...

(Adopts John Cleese voice from A Fish Called Wanda while being dangled out of the window upside down by Kevin Kline)....

"We apologize unreservedly to fans of precious metals. At no time did we ever seek to criticize, or intend to disparage the said metals, or their adherents and enthusiasts. We therefore regret any mental anguish that may have resulted. Any accidental similarity between the aforementioned "bugs" and any person living or dead is purely coincidental...."

Carry On Investing...

Saul Bollox said...
8:17 PM  

gold at $1400 by the end of next week!

some longs about to get crushed. Chart looks broken. Weekly close below 1600 would confirm it

I hope, so that I can buy there.. GGUF until it doesnt

abee crombie said...
8:49 PM  

europe, funding stresses, all so last quarter. This is all about global growth slowdown, fiscal restraint, and commodity nation excoriation. Get onto the new trend and forget the past.

I read so much today about Europe, when today was all about commodities and chinese demand...

Anonymous said...
10:54 PM  

I have no strong view on Gold here outside the question of how the general public would view the concept of it next year if it were to close negative this year. Point being, the metal has been positive for 11-yrs running and not too many other assets can say the same. Would be a big marketing tool removed if that was the case.... but still aways to go of course...

Right Field said...
11:02 PM  

Japanese business sentiment is "Tankan" again..

Japanese Tankan Survey

Sorry, we never get tired of that one....

Leftback said...
3:24 AM  

This 3m EURUSD basis swap has become one of my bugbears as well.
Suddenly, it has become every journo's favourite stress indicator. But what does it really mean? Good names source USD directly, bad names have had their lines pulled, so we seem to be measuring the spread charged to just about the worst banks that still have credit lines?! There's some information in that, but not all that much.

In a market characterised by extreme credit tiering, where credit is being rationed more by quantity than price, one has to question the value of this indicator.

VandalsStoleMyHandle said...
7:51 AM  

Vandals.. well said , you are spot on.

Polemic said...
9:42 AM  

TMM always has an interesting perspective, even if sometimes their models are wrong [hello Chinese pmi!] at least it challenges the zerohedges "we are all doomed" and the goldmans type's "everything is fine, and please buy these things we are making a market in because they are going to kill [but probably only you]"

Anonymous said...
12:01 PM  

Vandals, can you elaborate on the most recent comment, regarding good names source USD directly and also credit being rationed by Q vs P.

Interesting thoughts.

abee crombie said...
2:31 PM  

Thanks for the quality comment stream.. but a quick interjection to thank the last anon donor to the xmas appeal who basically filled the remaining bid. Thank you, done with style...

Though we won t be moving the target we do of course bid on..!

Thanks again to everyone who has contributed so far..
Pol and the team.

Polemic said...
4:08 PM  

abee crombie, nothing too profound, I'm afraid. Good names would still have access to USD funding through USD repo, CP, USD retail etc. Rubbish names wouldn't have anyone to trade with - quantity rationing.

By quantity rationing I mean that, in this market, if someone starts getting a bit skittish about, let's say, second-tier Italian names, they won't show them a price 25bp wider (price rationing), they'll cut their line (quantity rationing).

This phenomenon of extreme tiering and quantity rationing affects most money market indicators, but I think the case of our cause celebre, the EURUSD basis swap, is particularly egregious. There is no way to conceptualise a clearing price under such circumstances; rather what we see when we talk about 'the price' is a somewhat arbitrary snapshot of a particular point in the penumbra of the money markets. It's interesting enough to observe, but hardly has the significance that the nattering nabobs of negativism would have you believe.

VandalsStoleMyHandle said...
4:50 PM  

Another new ETF, TMM... shouldn't the ticker be WMKR?


Leftback said...
5:23 PM  

C says'
Short JGB.
At some point the idea that debt held domestically that can also be serviced by increasing taxes isn't the best trade prospect out there.
I know of one prior 'superstar' fund manager whose been trying unsuccessfully to ride that horse all year.
Sometimes when you don't succedd at first it's better to just give up.

Anonymous said...
8:04 PM  

JGB 10 Years at 1%, tradeoff looks good if you can hold it. No catalyst on horizon to really shake this, but then usually there isnt one untill its too late.

Intrinsic said...
9:55 PM  

Thanks vandals for the elaboration. Makes sense. I'm always trying to improve my knowledge of the money markets as you never know when its valuable

abee crombie said...
8:13 PM  

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