And in markets few things are more important than the appearance of adequate liquidity. Isn't that what Fed Chair Janet Yellen's recent squealing about invoking exit fees on money markets was all about?
Well, a story in the Financial Times today, "Repo fails spark fears of risk to US Treasuries," calls attention to what could be another liquidity squeeze waiting in the wings to happen.
US Treasury bonds are supposed to be some of the easiest to buy and sell, yet all is not well in one of the world's biggest and most liquid markets.
The smooth functioning of the $12tn US Treasury market depends on the health of its underlyoing machinery, in particular the repurchase, or "repo," market. This is where government securities are regularly lent out and borrowed between various investors and dealers.
These are short term transactions that help investors sell bonds when they want to change directions as in the face of suspected rising interest rates. In other words, it about liquidity. The whole system depends on, guess, paying the piper or returning your securities on time.
Something called a failure happens when a borrowed security is not returned on time and causes settlement problems across the entire "repo" landscape. As is usually the case since these securities are lent out more than once there is more than just borrower and lender involved here.
Think of a daisy chain of borrows, banks and dealers. A couple of weak links and you're starting to get the picture. Of late, according the FT article, there's been a big jump in the fail rate. Per Federal Reserve data the peak in failures happened back in 2011.
Back in 2011 interest rates were declining not rising. Now even though there is what the Times calls subdued activity in this market, failures are on the rise. That brings up an ugly concern should interest rates move up higher or faster than anticipated.
As one market observer quoted by the Times puts it: "If the market is as liquid as everyone says it it, then why did we have this sudden burst of fails?" That sudden burst, the Times notes, since records have been kept occurred since the beginning of this June when "seven of the 10 largest fail-to-deliver days" hit the market.
So far none of the fails have come from dealers, but if that should occur it could signal look out below. Short-term debt plays a key role in keeping the current financial system afloat. It has to do with collateral. One thing adding to the problem is recent regulations. Fewer players now want to be a part of the daisy chain owing to the added costs of playing.
So much for every action evoking a reaction.
t. man hatter
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