EcoFlash

Looming money market tensions

Looming money market tensions  
Céline Choulet  
Huge injections of central bank money  
The Feds outstanding repo operations, USD bn  
Cash allocated (overnight and term repos)  
▪▪ Total demand seen during outstanding operations  
In the last three months, the US Federal Reserve has  
injected more than USD 360 bn of central bank money  
through repurchase agreement operations (repo) and  
outright purchases of T-bills.  
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It will ramp up its intervention further between now and  
31 December, to remove the risk of losing control of  
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short-term rates again because of the specific needs of  
market participants as they approach their financial year-  
end.  
By the year-end, if the volume of demand for repo  
transactions reaches the total amount offered by the Fed,  
USD 650 bn of central bank money will have been  
injected.  
However, even that huge amount of support could prove  
insufficient. That is due in particular to the planned  
increase in the Treasurys account with the Fed, the  
leverage constraints of broker-dealers and the G-SIB  
capital surcharge.  
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7-Sep 26-Sep 7-Oct 17-Oct 28-Oct 6-Nov 18-Nov 27-Nov 9-Dec1 8 -D ec
Figure 1  
Source: FRBNY, BNP Paribas  
dealers. Overall, and given the limits set by the Fed, the  
amount of liquidity injected amounted to USD 237 bn by 18  
December, while the demand for cash seen during the nine  
operations outstanding on that date amounted to USD 300 bn  
Money markets reliant on Fed injections  
On 16 and 17 September, the US money markets seized up:  
excessive demand for cash caused overnight borrowing rates  
to surge. This was mainly caused by regulatory liquidity  
requirements which, given insufficient central bank reserves,  
limited the ability of major banks to absorb the spike in  
(figure 1). In addition, the Fed has been buying T-bills outright  
since mid-October, at a rate of USD 60 bn per month.  
In the space of three months, from Wednesday 11 September  
to Wednesday 11 December, the measures taken by the Fed  
led to USD 328 bn of extra central bank money being injected  
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demand . To ease the pressure, the Federal Reserve has  
since 17 September been injecting central bank money  
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through overnight and term repo operations with primary  
(USD 213 bn via its repo operations and USD 115 bn via  
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C. Choulet (2019), The Fed’s new role under Basel 3, BNP  
repurchase agreement incorporates an undertaking to repurchase  
the security at a given point in time for an agreed price. The  
interest rate, or repo rate, is a function of the difference between  
the sale and repurchase prices. The Fed defines the operation as  
a function of its effect on its counterparty. Thus from the Fed’s  
point of view, a repo is similar to a collateralised loan and  
recorded as an asset whereas a reverse repo is a liability.  
Paribas, EcoFlash, October 2019  
2
A repo transaction  the temporary disposal of securities  can  
be considered, from an economics viewpoint, as a collateralised  
loan (cash against securities): from the point of view of the lender  
of the cash it is a reverse repurchase agreement; from that of the  
borrower of the cash it is  
a repurchase agreement. The  
EcoFlash // 19 December 2019  
economic-research.bnpparibas.com  
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securities purchases). This amount may have reached  
USD 367 bn on 18 December.  
Almost USD 230 bn of reserves drained by the  
increase in the Treasury General Account  
USD bn  
Change in central bank reserves since 11 Sep  
– – Injection of reserves through the increase in the Fed’s securities  
portfolio and repo operations  
The Fed has so far succeeded in easing the tension in the  
money markets. However, the specific needs of market  
participants as they approach their financial year-end could  
ramp up the pressure again (see below). As a result, the Fed  
announced on Thursday 12 December that it would increase  
its support. Overall, if the volume of demand for repo  
transactions reaches the amount offered by the Fed,  
USD 283 bn of additional central bank money could be  
injected by year-end, taking the total amount of support to  
▪▪▪ Reduction in reserves through the increase in the Fed’s other liabilities  
(cash in circulation, Treasury General Account, reverse repos)  
700  
Estimates  
+650  
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USD 650 bn . Huge though these numbers may seem, they  
may not be enough.  
+420  
A third of the liquidity injected will end up in  
Treasurys account with the Fed  
First, even if the demand for repo transactions reaches the  
total amount offered, bank reserves held with the Fed will not  
increase by USD 650 bn by year-end, because part of the  
liquidity injections will continue to finance the increase in the  
Treasury General Account (TGA, figure 2).  
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230  
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200  
300  
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Between 11 September and 11 December, bankscurrent  
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accounts with the Fed only swelled by USD 213 bn : this was  
Figure 2  
Source: Fed, FRBNY, Treasury, BNP Paribas  
because USD 28 bn of bank deposits were converted into  
notes and coins and, most importantly, because the  
Treasurys general account increased by USD 121 bn .  
USD bn  
350  
Collateral is proving hard to digest  
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Similarly, between now and year-end, given the ongoing  
increase in notes and coins in circulation (USD 7 bn) and the  
Net position of primary dealers in Treasury securities  
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likely increase in the TGA (USD 106 bn ), bank reserves are  
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only expected to rise by USD 209 bn , taking them to around  
300  
USD 1,880 bn, the same level as in October 2018.  
Finally, during the period in question (11 September 2019 to 1  
January 2020), the amount of cash held by banks with the  
Fed is only likely to rise by USD 420 bn. A third of the Feds  
cash injections will therefore have served, indirectly, to  
increase the TGA.  
250  
200  
150  
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The impact of regulations on the money  
markets is underestimated  
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In addition, beyond liquidity requirements, capital  
requirements could also be playing a role in disrupting the  
money markets at the moment that market participants close  
their annual accounts.  
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Dec-15  
Dec-16  
Dec-17  
Dec-18  
Dec-19  
Figure 3  
Source: FRBNY  
Leverage constraints  
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Overall, central bank liquidity injections would total USD 650 bn,  
Investors lack of appetite for Treasury issues has led to an  
unprecedented increase in primary dealersinventories of  
Treasuries (figure 3). Since mid-September, primary dealers  
have been able to refinance their net positions through repo  
operations with the Fed. However, those operations are taking  
place on the tri-party repo platform, with Bank of New York  
Mellon playing the role of clearing bank. The use of the tri-  
party repo market means that positions cannot be netted,  
unlike operations taking place via the Fixed Income Clearing  
Corporation (FICC). Ahead of their financial year-end, there is  
a risk that the liquidity offered by the Fed through its repo  
operations may not be accessible to the dealers most  
comprising USD 490 bn via repo operations (USD 150 bn of  
overnight repos + four 14- or 15-day operations of USD 35 bn  
each + three 28- or 42-day operations of USD 25 bn each + one  
2-day operation of USD 75 bn + one 32-day operation of  
USD 50 bn) and USD 160 bn via outright purchases of securities.  
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For USD 328 bn of liquidity injected.  
Those two increases have been offset slightly by a reduction of  
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around USD 32 bn in the Feds reverse repo operations.  
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In July 2019, the Treasury announced that it would increase its  
cash balance with the Fed to USD 410 bn by the end of the year.  
It is currently planning to issue USD 389 bn of debt securities in  
the first quarter of 2020 and stabilise its cash balance at  
USD 400 bn at end-March 2020.  
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For USD 322 bn of liquidity injected and assuming an  
unchanged amount of outstanding reverse repo operations with  
foreign central banks.  
EcoFlash // 19 December 2019  
economic-research.bnpparibas.com  
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constrained by their leverage requirements . Neither are the  
Feds T-Bill purchases enabling dealers to offload their large  
inventories of coupon bonds, which make up 85% of their  
particular at the financial year-end when, for example, foreign  
banks stop circulating cash borrowed from money market  
funds to other participants that cannot access those funds, or  
when dealers seek to make greater use of repo markets that  
allow netting. These markets need a lender of last resort. But,  
the Feds facilities, given their characteristics in terms of  
counterparties and types of repo, may not be able to absorb  
the effect of these year-end adjustments.  
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Treasury portfolios .  
There is a widespread belief among central bank officials that  
the tension in US money markets is being caused by  
excessive concentration of “excess” reserves. It is true that  
the eight systemically important US banks alone account for  
almost half of reserves held with the Fed. There is a good  
reason for that: they are very large institutions (accounting for  
3% of total assets) and are therefore subject to much stricter  
liquidity requirements, which increase their needs for central  
bank money (on an intraday, not overnight, basis) . They  
also include the only two institutions (at least until the end of  
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The G-SIB surcharge  
The effect of these adjustments on the repo and forex swap  
markets could also be exacerbated by the withdrawal of  
certain large US banks keen to minimise their G-SIB  
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surcharges .  
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017 in JP Morgans case) that play the role of clearing bank  
For reference, regulators require banks whose failure could  
create a global systemic risk (Global Systemically Important  
Banks or G-SIBs) to carry additional capital. In the US,  
regulators calculate that additional capital using two methods,  
and the higher figure is the one adopted. The FSB method is  
based on the five criteria used to identify G-SIBs: the size of  
banks, their interconnectedness, the lack of readily available  
substitutes or financial institution infrastructure for the  
services they provide, their cross-jurisdictional activities and  
their complexity. Based on a system of tranches, a capital  
surcharge is applied to each institution on the basis of its  
relative score. The second method replaces the lack-of-  
substitutes criterion by a measure of a banks dependency on  
short-term market financing, and favours an absolute  
in the tri-party repo market.  
However, we believe that the pressure on liquidity stems from  
dwindling reserves, and probably also from their lesser  
concentration. In the fourth quarter of 2018, the same  
pressure on money market rates was avoided because the  
largest commercial bank (JP Morgan National Association)  
met most of the overnight refinancing demand: its reverse  
repo positions increased by USD 110 bn while its reserves fell  
by USD 130 bn (figure 4). Currently, however, certain large  
banks no longer have excess reserves as regard their liquidity  
requirements. It is only those large banks (in particular JP  
Morgan) that are (or were) able to absorb potential shocks, in  
Reserve scarcity?  
Balance sheets’ adjustment ahead of end-year?  
G-SIB scores (method 2), thresholds and corresponding surcharges  
Reserves held by the four largest US commercial banks with the Fed at 30  
September, USD bn  
at 30 September 2018  
at 30 September 2019  
at 31 December 2018  
2017 2018 2019  
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3
3
2
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00  
7
30  
30  
4%  
50  
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3.5%  
3%  
00  
50  
00  
50  
00  
5
4
30  
30  
2.5%  
2%  
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2
30  
30  
1.5%  
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0
130  
1%  
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JP Morgan NA  
Wells Fargo Bank Bank of America NA  
NA  
Citibank NA  
JPM  
BoA  
CITI  
WF  
GS  
MS  
BONY  
STT  
Figure 4  
Source: FDIC Call Reports  
Figure 5  
Source: SNL Financial, Fed, BNP Paribas  
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Their assets must not exceed 15 times their capital.  
https://www.sec.gov/about/offices/oia/oia_market/key_rules.pdf  
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This could force the Fed’s hands towards purchases of  
coupons. See Z. Pozsar (2019), Countdown to QE4 ?, Global  
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G-SIB surcharges calculated on the basis of end-2019 balance  
Money Notes #26, Credit Suisse Economics, December 2019  
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JP Morgan, Bank of America, Wells Fargo, Citigroup, Goldman  
sheets will not be announced until November 2020, before  
coming into force on 1 January 2022. At the moment, the  
leverage requirements and stressed risk-weighted capital  
requirements (which do not include the G-SIB surcharge) are  
tougher than the non-stressed risk-weighted capital requirements.  
However, with the introduction of the Stress Capital Buffer, which  
will merge the stressed and non-stressed requirements, the G-  
SIB surcharge will become much more binding.  
Sachs, Morgan Stanley, Bank of New York Mellon and State  
Street  
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See note 1. It is also worth noting that the number of banks  
subject to the Basel short-term liquidity (LCR) requirement is very  
low in the USA (currently 37). See C Choulet (2019), A more  
gradualist approach to US banking regulation, BNP Paribas,  
EcoFlash, November 2019  
EcoFlash // 19 December 2019  
economic-research.bnpparibas.com  
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measurement of each banks systemic importance. The  
second method almost always results in a larger surcharge  
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than the first .  
Based on the second method and balance sheets of the third  
quarter of 2019, the G-SIB surcharges for JP Morgan, Bank of  
America and Goldman Sachs could be increased by 50 basis  
points at the end of the year (from 3.5% to 4% for JPM, from  
14  
.5% to 3% for BoA and GS, see figure 5) . Past experience  
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shows that banks whose systemic importance scores are  
close to a cut-off point tend to reduce their complexity,  
interconnectedness and cross-jurisdictional activity scores in  
the last quarter of the year in order to minimise their  
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surcharge . An effective way of reducing those scores is by  
not renewing overnight loans and borrowings in the repo and  
forex swap markets.  
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Based on end-2018 balance-sheet data, the second method  
results in surcharges that are 50100 basis points higher  
depending on the bank (except for State Street, for which the two  
methods give the same result).  
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In addition, crossing the 630 threshold would increase  
Citigroups surcharge to 3.5%. Higher valuations for their  
securities portfolios explain part of the increase in G-SIB scores.  
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F. Covas (2019), The GSIB surcharge and repo markets, Bank  
Policy Institute, November 2019  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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