Two days ago we noted that as we approached the quarter end’s window dressing, when the financial system’s balance sheet most closely approaches what it would be like without Fed backstops if only for regulatory purposes, General Collateral – a closely followed indicator of dollar funding costs and thus of cash availability – spiked to the highest in 7 years, surging to 0.85% after opening the day at 0.68%.
We expected this number to keep rising as we neared the Sept 30 quarter end, and sure enough it did not disappoint: as SMRA points out, as of this morning, the overnight general collateral rate has soared to 1.25% – indicative of where funding would be had the Fed hiked not once but three times in 2016 – from an average of 0.89% yesterday. This is the highest that the GC rate has been since the financial crisis.
For those unfamiliar with GC repo, here is a quick primer from the ICMA:
General collateral or GC is the range of assets that are accepted as collateral by the majority of intermediaries in the repo market, at any particular moment, at the same or a very similar repo rate — the GC repo rate. In other words, the repo market as a whole is indifferent between general collateral securities. They are close substitutes for each other. GC assets are high quality and liquid, but none is subject to exceptional specific demand compared with very similar assets. The GC repo rate is therefore driven purely by the supply of and demand for cash (not by the supply of and demand for individual assets). In other words, GC repo can be said to be cash-driven. As such, the GC repo rate should be closely correlated to other money market rates, eg LIBOR, EURIBOR, etc, although trading at a spread representing the lower credit and liquidity risks in repo.
Said otherwise, a spike in GC repo is indicative of not only some major plumbing blockage in the repo market, but a funding shortage, the kind that we showed earlier today in Europe.
To be sure, the move was not unexpected: the GC rate had been rising for the majority of the week. Every quarter for over a year has seen a spike in GC, as money funds face increased regulations and need to streamline their balance sheets. Previous quarter ends saw sharp drops the following day, though the jump in GC at the end of Q2 took a couple weeks to drop down to more usual levels. However, with that in mind, one look at the chart below shows that while indeed previous quarter-end periods have seen a substantial pick up, there has never been a collateral shortage as bad as currently:
Bloomberg tried to away the outlier print, noting that “the latest spike in O/N GC repo to a post-financial crisis record high reflect impact of regulatory changes in market structure that have made quarter-end financing more expensive rather than any concerns around Deutsche Bank’s woes, analysts say” although we would not be so certain, especially when considering a chart we first presented previously showing the use on the ECB’s 7-day lending facility, confirming the dramatic USD shortage in Europe, which also has surged to the highest in years. Somehow we doubt this is related only to “regulatory changes” or quarter end.
For those who prefer the more conventional explanation that there is nothing ulterior in the biggest surge in the cost of cash, here are some further pointers from Bloomberg:
Basel capital rules drive banks to curtail the size of matched book repo before quarter-end. “The process of paring down balance sheet heading into the turn has become a month-long process, where sellers of dates that bridge quarter-end are extremely aggressive,” Jefferies economist Thomas Simons said in note.
“Constraints are leading to bizarre distortions’’ in the market; interdealer markets were trading 50+ bp higher than “anything else in the front-end.”
Banks act as an intermediary between money funds, which have cash to invest and clients looking to fund long positions; when banks cut the size of their repo book, spread between tri-party and GCF rates widens.
While European banks’ short-term funding costs are climbing amid Deutsche Bank’s financial woes, a re-visit of the 2008 levels is unlikely as excess liquidity is almost four times what it was then, Bloomberg strategist Richard Jones writes.
It sure is, and yet the GC is trading at a level that implies funding conditions are about 3 times tighter than where they should be based on the Fed’s interest rate.
Whatever the reason for the surge, keep track of this data series. While it should drop sharply on Monday, if the tightness of funding persists it will clearly suggest a far more serious issue is at hand.
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