Fear! Interest Rate Derivatives Trading Explodes to $6.5 Trillion Per Day

Brexit, slowing global growth, Central Bank monetary follicies (negative rates). Lots of economic uncertainty and a growing demand to hedge interest rates. In other words, lots of fear.

According to the BIS, daily turnover of OTC interest rate derivatives averaged $6.5 trillion in April 2019, up markedly from the April 2016 survey when it averaged $2.7 trillion per day. This rise appears to have been driven mainly by increased hedging and positioning amid shifting prospects for growth and monetary policy.

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However, other factors also played a role. Much of the turnover in April 2019 was in shorter-term contracts, which are rolled over more often. In addition, the 2019 survey saw more comprehensive reporting of related party trades than in previous surveys. Average daily turnover in April 2019, after adjusting for these trades, is estimated to have been closer to $5.8 trillion in April 2019, up around 120% since the 2016 survey.

The majority of turnover of OTC interest rate derivatives is in swaps and denominated in the mighty US dollar.

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The home of the largest turnover (aka, trading) is in the UK, followed by Hong Kong and then the USA.

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Yes, lots of fear regarding interest rates.

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Perry Omo? Fed Will Likely Restart QE In November (SOFR, Repo Rates Stabilize To Near Normal)

Is Fed Chair Jerome Powell really Perry Como? Or Perry OMO?

To the disappointment of many, Powell did not lower the target rate by 50 points and did not announce a resumption of QE.  Instead, the FOMC realigned both interest on excess reserves (IOER) and the reverse repo (RRP) rate lower by 5bp. Powell noted during his press conference that the Fed would use temporary open market operations (OMOs) “for the foreseeable future” to address pressures in funding markets.

However, and the reason why stocks shot up just before 3pm ET, is that that’s when Powell added that “it’s possible that we’ll need to resume the organic growth of the balance sheet, earlier than we thought. … We’ll be looking at this carefully in coming days and taking it up at the next meeting” in late October. Said otherwise, the Fed may not have announcer QE4 yesterday, but it will likely announce it in the very near future.

Sure enough, as Goldman wrote in its FOMC post-mortem, “we took this as a fairly strong hint and now expect the Fed to resume trend growth of its balance sheet in November with permanent OMOs. It is possible that the FOMC will take that opportunity to also reach a final decision on possibly shortening the maturity composition of its purchases, which it discussed at its May meeting.”

With all the OMO (or Perrys), the Fed’s Secured Overnight Finance Rate (SOFR) stabilized to normal levels.

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And the repo rate returned to near normal with the massive intervention with OMO.

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Fed Chair Jerome Powell (aka, Perry Omo).  Hot diggity dog. …

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On a side note, I tripped on a weight at the gym and fell against a weight machine. Fractured rib, badly swollen knee and dislocated perhaps broken finger(s). I call for a ban on power lifters dropping their weights and having them bounce in front of me!

The Crazy World Of Jerome Powell: Fed’s FOMC Lowers Target Rate By 25 BPS As Repo, SOFR Rates Balloon, Dow Drops Over 150 Pts

The Fed is the God of Hellfire!

The FOMC lower the Fed’s target rate by 25 basis points to 2.00%.

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The NY Fed’s SOFR rate ballooned to 5.25%.

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The GCF Repo Index ballooned to 6%.

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The US Treasury and Dollar Swaps curves remain … kinky.

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On the news, the Dow tanked over 160 points. Is the market signaling too little for the rate cut?

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The Crazy World of … Jerome Powell.

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SOFR Soars As Bond Market Liquidity Seemingly Vanishes Ahead Of Fed FOMC Meeting

What up with that?  Financial markets have gone crazy as liquidity seemingly vanishes.

(Bloomberg) — The U.S. money-market interest rate remained elevated for a third straight day, after rising to a record Tuesday.

The rate on overnight general collateral repurchase agreements, or repos, was at 2.8% early Wednesday, based on ICAP pricing. On Tuesday, it jumped to 10%, about four times greater than last week’s levels, as cash reserves in the banking system remained out of balance with the volume of securities on dealer balance sheets.

Today there was a whopping $80.05BN in bids submitted, an increase of $27 billion, or 50% more than yesterday.

It also meant that since the operation – which is capped at $75BN – was oversubscribed by over $5BN.

And the New York Fed’s Secured Overnight Financing Rate soared.

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Uh oh. Has The Fed lost control?

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Photo from Jesse’s Cafe Americain.

The Big Squeeze! GC Repo Rate Crashes To 0% Amid Liquidity Squeeze And The Fed’s $53.2 Billion Flood Of Liquidity

Panic?

(Bloomberg) — The Federal Reserve took action to calm money markets on Tuesday, injecting billions in cash to quell a surge in short-term rates that was pushing up its policy benchmark rate and threatening to drive up borrowing costs for companies and consumers.

While the spike wasn’t evidence of any sort of imminent financial crisis, it highlighted how the Fed was losing control over short-term lending, one of its key tools for implementing monetary policy. It also indicated Wall Street is struggling to absorb record sales of Treasury debt to fund a swelling U.S. budget deficit. What’s more, many dealers have curtailed trading because of safeguards implemented after the 2008 crisis, making these markets more prone to volatility.

Money markets saw funding shortages Monday and Tuesday, driving the rate on one-day loans backed by Treasury bonds — known as repurchase agreements, or repos — as high as 10%, about four times greater than last week’s levels, according to ICAP data.

More importantly, the turmoil in the repo market caused a key benchmark for policy makers — known as the effective fed funds rate — to jump to 2.25%, an increase that, if left unchecked, could have started impacting broader borrowing costs in the economy. Because that’s at the top of the range where Fed officials want the rate to be, they are likely to make yet another tweak to a key part of their policy tool set to try to get things back on track when they meet Wednesday to set benchmark rates.

But the central bank didn’t wait until then to do something, resorting to a money-market operation it hasn’t deployed in a decade. The New York Fed bought $53.2 billion of securities on Tuesday, hoping to quell the liquidity squeeze. It appeared to help. For instance, the cost to borrow dollars for one week while lending euros retreated after almost doubling Monday.

For repo traders, hedge funds and others that rely on that market for financing, this intervention came none too soon.

A bit of an overshoot?

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And something that went unnoticed by many …

The New York Fed bought $3.001b of T-bills in the secondary market Tuesday as part of its planned reinvestment purchases.

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Yes, it is The Big Squeeze (not to confused with The Big Short).

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What up with that?

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The Big Short: Part Deux? US Home Prices Slow As Wage Growth Highest Since Early 2009 (Tiny Bubble OR BIG Bubble?)

No matter which US home price index you choose, US home prices have risen above the peak of the housing bubble in April 2007 (as highlighted in the book and film “The Big Short”).

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Thanks to relaxed credit standards, including the infamous NINJA (no income, no job) loans, the US saw a steady and increasing growth in mortgage credit and a corresponding growth in home price growth … until 2005. Then the bottom fell out out the housing market.

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Today, we are witnessing a slowing of home price growth even as earnings growth is at its highest level since early 2009.  The last time we saw home price growth and earnings growth so in alignment was back in the 1995-1998 period following the enactment of HUD’s National Homeownership Strategy. 

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The big difference between the 2000s housing bubble and today’s housing bubble is that the 2000s housing bubble was driven by subprime and ALT-A credit. But today’s housing bubble is in part driven by foreign investors on both the west and east coasts, not to mention the Federal Reserves low interest-rate policies. And we are seeing a softening of credit standards from Fannie Mae and Freddie Mac.

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And Fannie and Freddie’s debt-to-income (DTI) is rising to 2008 (financial crisis levels).

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So does the US have a tiny bubble? Or a big bubble?

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Draghi Goes Big! Draghi Faced Unprecedented ECB Revolt as Core Europe Resisted QE (France, Germany Versus Spain, Italy, Greece)

This reminds me of the Mel Brooks skit “The people are revolting.”

It this case, it is France and Germany resisting more QE while “the people” (Spain, Italy and Greece) are revolting and pushing for more QE.

(Bloomberg) — European Central Bank governors representing the core of the euro-area economy resisted President Mario Draghi’s ultimately successful bid to restart quantitative easing, according to officials with knowledge of the matter.

The unprecedented revolt took place during a fractious meeting where Bank of France Governor Francois Villeroy de Galhau joined more traditional hawks including his Dutch colleague Klaas Knot and Bundesbank President Jens Weidmann in pressing against an immediate resumption of bond purchases, the people said. They spoke on condition of anonymity, because such discussions are confidential.

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Those three governors alone represent roughly half of the euro region as measured by economic output and population. Other dissenters included, but weren’t limited, to their colleagues from Austria and Estonia, as well as members on the ECB’s Executive Board including Sabine Lautenschlaeger and the markets chief, Benoit Coeure, the officials said.

Mario Draghi says the ECB will maintain a “highly accommodative stance of monetary policy.”

Such disagreement over a major monetary policy measure has never been seen during Draghi’s eight-year tenure. It casts a shadow over the resolve underpinning his parting stimulus shot before Christine Lagarde succeeds him, and also over his account of the proceedings. The extent of the rift might open the door to critics of the institution to question the legitimacy of its decisions.

Despite the disagreement, Draghi presented the decision to relaunch QE as having enough support to move forward. There was no vote on the matter, in line with typical ECB practice. Such a ballot would be a rare occurrence, but if one had taken place, under the Governing Council’s system of rotation to streamline decision-making, the French and Estonian governors would have been unable to cast a vote this month.

“There was more diversity of views on APP. But then, in the end, a consensus was so broad there was no need to take a vote. So the decision in the end showed a very broad consensus. As I said, there was no need to take a vote. There was such a clear majority.” 
– Mario Draghi, Sept. 12 press conference in Frankfurt

One key argument wielded by policy makers opposed to Draghi’s resumption of QE was that it would be better to save it to use as a contingency in an emergency, such as an abrupt outcome to Brexit if the U.K. leaves the European Union without a transition deal, the officials said.

Spokesmen and spokeswomen for the Austrian, Dutch, Estonian, French and German central banks declined to comment on the ECB discussions. An ECB spokesman also declined to comment.

QE has previously proved contentious. Draghi encountered significant opposition in 2015, when he pushed the Governing Council to start bond purchases, against the wishes of his German, Dutch, Estonian and Austrian colleagues.

Draghi’s decision to press ahead without such key support risks leaving Lagarde with a headache when she starts in November. She will need to decide whether to persist in a policy that has divided her Governing Council, risking further acrimony. The alternative would be to dial back the ECB’s current stimulus commitments, an approach that could provoke a market backlash.

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That’s what she said.

Seriously, how much extra QE does Spain, Italy and Greece want?

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Is it because their banking systems are still in the doldrums? Here is a sample of an Italian, Spanish and Greek bank.

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What I Like About Central Banks … NOT! Global Central Banks Pushing Interest Rates Lower Towards Negative Territory

The CFR Global Monetary Policy Tracker is updated through September 1. The Index of Global Easing(-)/Tightening(+) holds steady at -6.68, significant easing, as markets anticipate a further Fed rate cut this month.

Easing monetary policy are Brazil, Chile, Peru and Colombia in South America, the European Central Bank, Australia, China, Turkey, Poland and Finland. Tightening? Pakistan, Sweden, the UK and Canada.

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Almost 80% of negative yielding debt is held by global central banks.

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So, what I like about Central Banks?? Nothing, as they continue their nosedive into negative interest rate territory.

Or as Borat said, … NOT!

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Briar Patch: Wells Fargo, Bank of America, Quicken Loans, Others Want DTI Requirement Eliminated From QM Lending Rules

Yes, the patch for Fannie Mae and Freddie Mac from the Consumer Financial Protect Bureau (CFPB) gives some lenders an advantage over other lenders since F&F aren’t covered by the QM’s debt-to-income requirement.

Housing Wire — Four of the largest mortgage lenders in the country are leading a coalition that is calling on the Consumer Financial Protection Bureau to make to changes to the Ability to Repay/Qualified Mortgage rule.

Specifically, the group, which includes Bank of America, Quicken Loans, Wells Fargo, and Caliber Home Loans, wants the CFPB to do away with the QM rule’s debt-to-income ratio requirement.

The Ability to Repay/Qualified Mortgage rule was enacted by the CFPB after the financial crisis and requires lenders to verify a borrower’s ability to repay the mortgage before lending them the money.

The rule also includes a stipulation that a borrower’s monthly debt-to-income ratio cannot exceed 43%, but that condition does not apply to loans backed by the government (Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture).

Additionally, Fannie Mae and Freddie Mac are not bound this requirement either, a condition known as the QM Patch. Under the QM Patch, loans sold to Fannie or Freddie are allowed to exceed to the 43% DTI ratio.

But some in the mortgage industry, including Federal Housing Finance Agency Director Mark Calabria, believe that the QM Patch gave Fannie and Freddie an unfair advantage because loans sold to them did not have to play by the same rules as loans backed by private capital.

But the QM Patch is due to expire in 2021, and earlier this year, the CFPB moved to officially do away with the QM Patch on its stated expiration date.

And now, a group of four of the 10 largest lenders in the country are joining with some sizable trade and special interest groups to call on the CFPB to make changes to the QM rule in conjunction with allowing the QM Patch to expire.

This week, Wells Fargo, Bank of America, Quicken Loans, and Caliber Home Loans joined with the Mortgage Bankers Association, the American Bankers Association, the National Fair Housing Alliance, and others to send a letter to the CFPB, asking the bureau to eliminate the 43% DTI cap on “prime and near-prime loans.”

As the group states, a recent analysis by CoreLogic’s Pete Carroll showed that the QM patch accounted for 16% of all mortgage originations in 2018, comprising $260 billion in loans.

But the group notes that the QM Patch (or GSE Patch, as they groups refer to it as in their letter) has limited borrowers’ options for getting a mortgage. And the group believes that removing the DTI cap will allow for a responsible expansion of lending practices.

Of course, lenders can always avoid the patch by selling originated loans to Fannie Mae and Freddie Mac.

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Laurie Goodman at the Urban Institute has argued that the DTI ratio is misleading. But it is clear from the above chart (produced by George Mason University School of Business  finance students) that average DTI has been rising since 2012.

CFPB’s “patch” or briar patch is a form of regulatory arbitrage since lenders can evade regulations but selling loans to Fannie Mae and Freddie Mac.

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