Wednesday, May 9, 2018

Russia Insider — Putin Starts Fourth Term by Sacking Several Senior Ministers

No post for the liberal Kudrin, but the fiscal hawk Siluanov heading the treasury is promoted to First Deputy Prime Minister
Russia Insider
Putin Starts Fourth Term by Sacking Several Senior Ministers




17 comments:

Footsoldier said...

Matt,

Somebody sent me this when I was talking about your theory on leverage ratios.




This is your chart of the day:-

Liquidation

https://pbs.twimg.com/media/DcmO7C5W4AInsON.jpg:large

Which feeds into our discussions on the leverage ratios of US banks, and the pressures on the US$ yield curve - especially the divergent expectations of interest rates and the rate at which banks will commit their balance sheets (OIS versus LIBOR).

Monetary conditions are tightening without the Fed lifting a finger. Are they happy with this? They could risk losing control of market rates unless they are prepared to crush rates with repos, which would attract accusations of resuming QE by stealth.

They were worried that when they came to raise rates, banks wouldn't respond by passing them on, and so they set up structures to allow non-banks to access the reserve rate directly, through reverse repos.

They didn't expect The Trump! He's turned everything upside down.


What do you think ?

Footsoldier said...

He dosen't think that the graph is fundamental. But it illustrates the pressures on rates simply due to the supply of longer duration assets.

The private sector savings exist to adsorb them, but first the banks are required to intermediate the flow. And they are constrained by (i) the leverage ratios (ii) their reduced capacity to take on trading risks and (iii) the difficulty of persuading the non-bank sector to extend duration when rates are rising.

In the case of Apple et al, the portfolio adjustment required of the non-bank private sector has additional friction. An "investor" in Apple is not the most obvious person who would re-save in corporate bonds, and (at the individual) level, post capital gains tax, does not have the resources to do so.

Indigestion is to be expected. It's a negotiation. The Fed could set the terms, but does it want to do so?

That's his real question.

Matt Franko said...

Looks like Apple might be cashing up some securities to pay the new tax Trump imposed Jan 1 on the previous global earnings ... have to use deposits to pay the tax not securities...

When they pay it we should see it in Table 4 of the Daily Treasury Statement...

Konrad said...

Bad link.

Corrected link below (Russia Insider)...

https://russia-insider.com/en/putin-starts-fourth-term-sacking-several-senior-ministers/ri23397

Footsoldier said...

If it isn't Matt

Does it illustrate the pressures on rates simply due to the supply of longer duration assets ?

Did they set up structures to allow non-banks to access the reserve rate directly, through reverse repos ?

Does the FED want to set the terms for Indigestion ?



Matt Franko said...

What do you mean by this:

“Monetary conditions are tightening without the Fed lifting a finger”

Flattening yield curve? Or the fact that Apple is selling?

Tom Hickey said...

Thanks, Konrad. Fixed now.

Footsoldier said...

Based on his belief that short-term market rates have moved up more sharply than the anticipated rate on Fed funds, because of the supply of bills and bonds and the need for the banking system to finance them, at least temporarily.

kim said...

I'm referring (largely) to the OIS - LIBOR spread. That has eased a bit (I'm afraid that I don't have a Bloomberg to give you an up to date picture).

OIS is a swap, which incurs very little balance sheet cost, and therefore is a reasonable proxy for assessing expected future policy rate developments.

Additional factors affect LIBOR, because LIBOR is the rate charged for "on balance sheet" deposits. So you have deposit insurance,and the difficulty in establishing a single rate for the banking sector as a whole, when it is not homogenous, and the composition of the tender panel can affect the rate. (Been there, done that, the impact can be huge. LIBOR is not investible if you have risk limits on particular banks which are part of the panel.)

But now also consider capital. The anticipated cost to a bank of funding its balance sheet is not the expected policy rate over the term of the contract, since banks are capital constrained, capital costs money, and there is now a large flow of longer duration instruments that the banks are being asked to warehouse prior to distribution to the non-bank sector at an uncertain price. So now also introduce both external and internal risk limits. Banks have been forced to cut proprietary trading positions with a consequential reduction of liquidity and an increase in the risk of warehousing.

All of this can lead to indigestion, and without Fed action, to an increase the market rates at which banks will acquire assets.

Hence, an effective monetary tightening. It's effectively a negotiation. How much is the Fed prepared to pay the commercial banks to help it reduce the Fed's balance sheet, which seems to be a key objective?

Footsoldier said...

Thanks Kim that makes it easier

kim said...

@Footsoldier,

A lot of banking is about "cash usage", which is not simply the cost of cash as suggested by the expected evolution of central bank policy rates, but about the cost and availability of capital, and then the choices that an individual institution makes in deploying that scarce capital available to it, and risk limits.

An analogy. Simple interest rate parity between the deposit rates of two currencies should determine the forward FX rate relative to the spot. It does not. Since forward FX positions require additional use of capital, and risk limits constrain the banks from running unconstrained open positions. If the non-bank sector is in aggregate trying to sell currency A for B, bank risk limits are quickly hit, and then the price deviates from the naive calculation.

Hence the basis swap market. The difference between the market and theoretical price.

(Other issues also affect the basis swap rates, which are quoted relative to the LIBORs in the two currencies, and these LIBORs are not comparable, see "composition of tender panels" above. There is "no" true single bank interbank rate, each bank has its own cost of funds. Each bank's liabilities are a different private sector currency, although central banks attempt to force them to trade equivalently.)

Footsoldier said...

Market parcipants ignore all of that and move the FX markets the wrong way on false beliefs.

Hence 95% of the time.

The fundamentals always win out in the end.

kim said...

But the price at which those participants can acquire their positions from wholesalers is dictated by (i) arbitrage and (ii) market capacity.

Answer me this. Most market participants believe that in the long-term equities will out-perform cash. (I don't agree, but that's me, and Jeremy Siegel is one of the most unimpressive pseudo-academics that I have had the misfortune to work with).

Now, what's the fair price for exchanging the terminal value of US$100 invested today in (i) an overnight cash account for (ii) the SPX all dividends reinvested (total return), at the end of 30 years?

Ignoring transaction costs and capital, the cost of that contract is zero. Because of arbitrage, not because of beliefs. If you believe (as most do) that equities will outperform cash, that's an insane price.

This is the dichotomy between pricing a contract based upon (i) the cost of hedging (which if perfect eliminates both upside and downside and is therefore risk neutral) and (ii) market expectations with a broad distribution of returns about an uncertain mean return, and the associated risk and reward.

They are quite different markets.

Footsoldier said...

They are and you make a strong case.

We are moving away from the topic here and I would like to see what Matt thinks.


However, there's 2 things here from previous discussions

1) You make a good theoretical case that if interest rates rise then the interest income channels don't matter that much.

2) You are now trying to make a strong theoretical case that price increases don't get passed on as much as we think.


But all the real economic data suggests both do and there is no getting away from that fact.

It's pointless going over and over it. We will all know afer the current rate hike cycle is finished. The markets will paint the picture for us.

So lets finish this for now.


Lets see what Matt thinks about the OIS - LIBOR spread and indigestion and what the FED will do.

Matt Franko said...

Foot when Kim says here:

“A lot of banking is about "cash usage", which is not simply the cost of cash as suggested by the expected evolution of central bank policy rates, but about the cost and availability of capital,“

What I am talking about is ‘availability’ of capital... there is effectively fixed capital over short time frames...

And banks assets are regulated against that fixed amount and both loans and reserve balances are both assets of the banks..

So if the asset value of loans increases (and this is not the loan balances it’s the asset values of the loans) then the bank will shed reserve assets...

kim said...

Matt, how does a bank shed reserve assets?

Okay, they can trade reserves, but as a whole the private banking system doesn't chose the reserve assets that it holds.

When there was a difference between required and excess reserves, with a lower rate applied to the latter, there was an incentive to lend (and therefore create deposits) so as to convert excess reserves to the more remunerative required reserves.

However, the central bank sets the amount of reserves at its discretion.

I don't understand this:-

"So if the asset value of loans increases (and this is not the loan balances it’s the asset values of the loans) then the bank will shed reserve assets..."

Reserves (when required) are not levied on loans, but on deposits, the value of which is independent of the value of the loans extended. The latter may affect capital, but not reserves, if we are talking about reserve balances with the central bank rather than provisions for losses. Often also called reserves, but a quite different thing. The former is an asset, the latter a liability.

kim said...

"The latter may affect capital, but not reserves"

The FORMER (sorry). Deposits determine the reserve balances required, loan valuations determine the amount of capital.