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“Down The Rabbit Hole” – The Eurodollar Market Is The Matrix Behind It All
“Down The Rabbit Hole” – The Eurodollar Market Is The Matrix Behind It All
Summary
- The Eurodollar system is a critical but often misunderstood driver of global financial markets: its importance cannot be understated.
- Its origins are shrouded in mystery and intrigue; its operations are invisible to most; and yet it controls us in many ways. We will attempt to enlighten readers on what it is and what it means.
- However, it is also a system under huge structural pressures – and as such we may be about to experience a profound paradigm shift with key implications for markets, economies, and geopolitics.
- Recent Fed actions on swap lines and repo facilities only underline this fact rather than reducing its likelihood
What is The Matrix?
A new world-class golf course in an Asian country financed with a USD bank loan. A Mexican property developer buying a hotel in USD. A European pension company wanting to hold USD assets and swapping borrowed EUR to do so. An African retailer importing Chinese-made toys for sale, paying its invoice in USD.
All of these are small examples of the multi-faceted global Eurodollar market. Like The Matrix, it is all around us, and connects us. Also just like The Matrix, most are unaware of its existence even as it defines the parameters we operate within. As we shall explore in this special report, it is additionally a Matrix that encompasses an implicit power struggle that only those who grasp its true nature are cognizant of.
Moreover, at present this Matrix and its Architect face a huge, perhaps existential, challenge.
Yes, it has overcome similar crises before…but it might be that the Novel (or should we say ‘Neo’?) Coronavirus is The One.
So, here is the key question to start with: What is the Eurodollar system?
For Neo-phytes
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Takeover
Takeover
We can’t print ourselves out of this crisis again, but that isn’t stopping the Federal Reserve from trying. Thursday’s intervention program, the latest in a string of panic moves to keep the financial system afloat, constitutes a complete takeover attempt of the market ecosphere, only the buying of stocks directly is last missing piece of eventual complete central bank control of equity markets. But seizing control of the bond market is the nearest equivalent step.
Not only that, the Fed is buying junk corporate debt propping up companies that should be let to fail as Chamath Palihapitiya pointed out poignantly this week. But not this Fed, no, with its actions it is again setting up the economy for yet another slower growth recovery, financed by even more debt.
QE doesn’t produce growth, that is the established track record:
Nobody wants to talk about the consequences to come following this crisis, but that doesn’t mean the consequences won’t be a real and present reality.
No, the Fed, while trying to save the world, is once again engaged in vastly distorting asset prices from the fundamental reality of the economy. It is in essence again laying the foundation for the next bubble, while the bursting of this bubble has yet to be fully priced in.
Even the Wall Street Editorial Board has made it perfectly clear what this is all about:
The @WSJ Editorial Board tells you what the new price distortion is all about: Save Wall Street and the top 1% and hope for trickle down economics later:https://www.wsj.com/articles/the-feds-main-street-mistake-11586474912 …
Asset price inflation to save markets in the hopes of trickle down growth to come.
Absurd.
The message the Fed is again is sending is to invite reckless behavior on the side of investors, the same reckless, TINA, fueled behavior that got us the bubble blow-off top in February.
…click on the above link to read the rest of the article…
The Fed’s Balance Sheet: The Other Exponential Curve
The Fed’s Balance Sheet: The Other Exponential Curve
As the threat of COVID-19 keeps millions of Americans locked down at home, businesses and financial markets are suffering.
For example, a survey of small-business owners found that 51% did not believe they could survive the pandemic for longer than three months. At the same time, the S&P 500 posted its worst first-quarter on record.
In response to this havoc, the U.S. Federal Reserve (the Fed) is taking unprecedented steps to try and stabilize the economy. This includes, as Visual Capitalist’s Marcu Lu details below, a return to quantitative easing (QE), a controversial policy which involves adding more money into the banking system. To help us understand the implications of these actions, today’s chart illustrates the swelling balance sheet of the Fed.
How Does Quantitative Easing Work?
Expansionary monetary policies are used by central banks to foster economic growth by increasing the money supply and lowering interest rates. These mechanisms will, in theory, stimulate business investment as well as consumer spending.
However, in the current low interest-rate environment, the effectiveness of such policies is diminished. When short-term rates are already so close to zero, reducing them further will have little impact. To overcome this dilemma in 2008, central banks began experimenting with the unconventional monetary policy of QE to inject new money into the system by purchasing massive quantities of longer-term assets such as Treasury bonds.
These purchases are intended to increase the money supply while decreasing the supply of the longer-term assets. In theory, this should put upward pressure on these assets’ prices (due to less supply) and decrease their yield (interest rates have an inverse relationship with bond prices).
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This Curve Will Never Flatten Again: Fed Balance Sheet Hits $6.1 Trillion, Up $2 Trillion In 1 Month
This Curve Will Never Flatten Again: Fed Balance Sheet Hits $6.1 Trillion, Up $2 Trillion In 1 Month
Here is an example of a curve that everyone wants to flatten.
And here is an example of a curve that while some – namely the bears – also wants to see collapse, it will never do so as that would mean the end of western civilization – which is now entirely contingent on the level of the S&P500 – as we know it. We are talking of course, about the Fed balance sheet which is now well above $6 trillion to make sure stocks and bonds don’t crash.
With that in mind here is all you need to know about this particular “curve”:
Total Fed assets grew by $293Bn to $6.08 trillion as of close, April 8, with the increase primarily driven by $294bn of Treasury securities added to the SOMA portfolio. Through its credit facilities, the Fed also extended $680bn in temporary liquidity to various counterparties, a decline of $61bn from last week.
In the past month, the Fed balance sheet has increased by $2 trillion, more than all of QE3, when the balance sheet increased by $1.7 trillion over the span of a year. The balance sheet increase has also been faster on a weekly basis than anything observed during the financial crisis, increasing as follows:
- April 8: $$272BN
- April 1: $557BN
- March 25: $586BN
- March 17:$356BN
Since the Fed needs to monetize all debt issuance this year, and probably every other year now that the Treasury and Fed have merged and helicopter money has arrived, the pace of the current QE is like nothing ever observed before:
And since we know what the Fed’s POMO schedule is for next week: an increase of $225BN in TSYs and MBS…
…click on the above link to read the rest of the article…
“Project Zimbabwe”
“Project Zimbabwe”
Roughly a month ago on the afternoon of Sunday, March 8th, Fed Chairman Powell had an emergency staff meeting.
Powell: I want the nuttiest money printing plan ever. What action plans do we have that are prepared and ready to initiate?
Admin: Well, we have this one named “GFC 2.0”
Powell: Sounds tame and sedate. Won’t impress anyone.
Admin: What about this one named “Whatever It Takes”
Powell: Lemme look… Meh… I want more shock and awe. This needs at least two more zeros.
Admin: Well, we have this other one named “Project Zimbabwe” but it’s so ridiculous that the Fed would forever lose all credibility…
Powell: hmmm… I like the sound of “Project Zimbabwe.” Just makes you want to turn dollars into toasters and washing machines to preserve wealth. This one will force guys so far out on the risk curve that they’ll think crypto-coins are value investments.
Admin: Yeah, it’s absolutely Wuhan-bat-shit nutty. We’d be criminally insane to unleash this on a population that isn’t prepared for hyperinflation…
Powell: Perfect!! Let’s have a press conference.
A few hours later…
Powell: Mr. President, I finally took rates to zero and launched QE infinity. Can you stop trolling me on twitter already? I can’t take any more of my wife cracking jokes about your tweets.
Trump: Be a man. You got it easy. Wait until you see what I do to Biden. He puts the “Dem in Dementia” haha…
Powell: Please, no more nasty tweets. Even my kids laugh at me.
Trump: Fine, but you’re thinking too small with “Project Zimbabwe.” Figure out how to print more aggressively. Look at what Mnuchin is doing with all his bailout programs. He’s gonna blow $10 trillion by early summer, then try to double that by election time. You better crank up that printing press of yours. I’ll stop tweeting if you keep monetizing the “Mnuchin Money.”
…click on the above link to read the rest of the article…
A Corporate-Debt Reckoning Is Coming
A Corporate-Debt Reckoning Is Coming
Corporate debt is the timebomb everyone saw ticking, but no one was able to defuse. Ratings agencies warned about it: Moody’s, S&P. Central banks and international financial institutions did too: the Fed, the Bank of England, the Bank for International Settlements, the IMF. Financial luminaries expressed concern: Jamie Dimon, Seth Klarman, Jes Staley, Jeffrey Gundlach, Henry McVey. Even a presidential candidate brought the issue on the campaign trail: Elizabeth Warren. Yet, as we’ve documented in these pages for more than two years, corporations have only piled on more debt as their balance sheet health has deteriorated.
Total U.S. non-financial corporate debt sits at just under $10 trillion, a record 47% of GDP. One in six U.S. companies is now a zombie, meaning their interest expenses exceed their earnings before interest and taxes. As of year-end 2019, the percentage of listed companies in the U.S. losing money over 12 months sat close to 40%. In the 12 months to November, non-financial S&P 500 cash balances had declined by 11%, the largest percentage decline since at least 1980.
For too long, record-low interest rates inspired complacency, from companies to lenders to regulators and investors. As we warned in WILTW August 8, 2019, corporate fundamentals will eventually matter. Now, with COVID-19 grinding the global economy to a halt, that time has come.
Systemic threats are littered throughout the corporate debt ecosystem. Greater than 50% of outstanding debt is rated BBB, one rung above junk. As downgrades come, asset managers will be forced to flood the market with supply at a time demand has dried up. Meanwhile, leveraged loans — which have swelled by 50% since 2015 to over $1.2 trillion — threaten unprecedented losses given covenant deterioration. And bond ETFs could face a liquidity crisis as a flood of redemptions force offloading of all-too-illiquid bonds (see WILTW January 31, 2019).
…click on the above link to read the rest of the article…
The Federal Reserve’s One Last Hail Mary
The Federal Reserve’s One Last Hail Mary
Over the last few weeks, the Federal Reserve has been in utter desperation mode to try to revive and keep the American economy on life support. What many in the mainstream media have failed to include in this recent coronavirus economic narrative is that the virus was just the pin of one the biggest bubbles ever created, which we call the central bank bubble revolving around U.S sovereign bonds.
Before we dive deep into this, let’s start with what the Fed has been doing to combat against the coronavirus and to keep markets alive for the time being. To begin, welcome back to the era of the printing press, but this time they have made it clear they will conduct “QE infinity” if this is a prolonged depression, which it will be.
For some prospective, previous QE programs were:
- QE1: $1.7 Trillion
- QE2: $600 Billion
- QE3: $1.6 Trillion
With this latest being:
- QE4:$1.6 Trillion
An overwhelming number in such a short period, making previous QE programs look like peanuts in comparison. In fact, the Fed printed roughly $970,000 every second last week to keep the market afloat. To validate that the Fed is artificially keeping the market alive, just look at this next chart:
This chart showcases that while the Fed balance sheet has shot up ($5.2 Trillion), corporate earnings have plummeted. The market is clearly on life support with the Federal Reserve as its temporary backstop. Presently, the aviation, hotel, and automotive industries, to name a few, are in a major crisis. This applies to all businesses, but since 2008 companies have taken advantage of prolonged zero interest rates and have gone on a total debt binge, with the majority of this debt going strictly to share buybacks and dividends to shareholders.
…click on the above link to read the rest of the article…
Nobody Knows Anything
Nobody Knows Anything
The more I read and observe the clearer the message: Nobody knows anything. And by that I mean nobody truly knows how any of this will turn out and I think this point needs to be driven home more clearly.
Tons of projections of this, that and the other. Just stop. I happen to think there are times to simply step back and not make grand predictions. For us that’s ok because we focus primarily on market technicals and that’s an ever evolving picture that offers us pivot points to decide when and where to get engaged in.
But on the macro? Give me a break. Nobody knows anything. Everybody is just guessing.
Exhibit A: GDP forecast for Q2:
Ok great. How’s that helping anyone in trying to value companies, cash flow, revenues, earnings? It doesn’t. -9% is a completely different planet than -40% and so is everything in between.
How does one qualify central bank and stimulus intervention? It changes every single day. Today the Fed cranked out an international repo program. Global central banks unite I guess. Also today Donald Trump tweeted about a $2 trillion infrastructure program. Who knows if it will happen. The Fed already increased its balance sheet by $1.3 trillion since the same time last year and may well be heading toward $9 or $10 trillion balance sheet position within a year. Last week they added $600B, basically all of QE2 in a week.
These are insane numbers thrown around, all on top of the $2.2 trillion stimulus package just passed. What’s the deficit going to be? I guess it depends on whether GDP drops by 40% or 9%.
Give me a break. How do you make any forecasts that have a predictive meaning whatsoever in this environment? Other than a lucky guess, the answer is nobody. Why? Because nobody knows anything.
…click on the above link to read the rest of the article…
Will Coronavirus End the Fed?
Will Coronavirus End the Fed?
September 17, 2019 was a significant day in American economic history. On that day, the New York Federal Reserve began emergency cash infusions into the repurchasing (repo) market. This is the market banks use to make short-term loans to each other. The New York Fed acted after interest rates in the repo market rose to almost 10 percent, well above the Fed’s target rate.
The New York Fed claimed its intervention was a temporary measure, but it has not stopped pumping money into the repo market since September. Also, the Federal Reserve has been expanding its balance sheet since September. Investment advisor Michael Pento called the balance sheet expansion quantitative easing (QE) “on steroids.”
I mention these interventions to show that the Fed was taking extraordinary measures to prop up the economy months before anyone in China showed the first symptoms of coronavirus.
Now the Fed is using the historic stock market downturn and the (hopefully) temporary closure of businesses in the coronavirus panic to dramatically increase its interventions in the economy. Not only has the Fed increased the amount it is pumping into the repo market, it is purchasing unlimited amounts of Treasury securities and mortgage-backed securities. This was welcome news to Congress and the president, as it came as they were working on setting up trillions of dollars in spending in coronavirus aid/economic stimulus bills.
This month the Fed announced it would start purchasing municipal bonds, thus ensuring the state and local government debt bubble will keep growing for a few more months.
The Fed has also created three new loan facilities to provide hundreds of billions of dollars in credit to businesses. Federal Reserve Chairman Jerome Powell has stated that the Fed will lend out as much as it takes to revive the economy.
…click on the above link to read the rest of the article…
What Will Be the Unintended Consequences of Printing Trillions of Dollars to Backstop the Entire System?
What Will Be the Unintended Consequences of Printing Trillions of Dollars to Backstop the Entire System?
Stocks are up somewhat this morning.
This marks the second Monday stocks will open in the green (last Monday was a green open as well) following two horrifically bad weekend sessions that saw stocks open limit down or close to limit down (March 2nd and 9th).
In the simplest of terms, the panic in the markets appears to be abating. It is clear stocks have broken the downtrend from the panic (blue lines). What is not clear is whether this rally will continue or not.
Stocks stalled out under resistance (red line) last week. A break above that line would open the door to a run to 3,000.
At the end of the day, stocks are actually a minor player in this mess. The BIG story is what happens with the bond markets.
Going into last week, it was clear the financial system was facing a debt crisis. Across the board everything from corporate bonds to municipal bonds were breaking down in a catastrophic fashion.
The Fed managed to stop this massacre by announcing it would backstop everything.
The question now is whether that will be enough. Bonds have staged a major bounce in the last five days, but what happens if they turn down again?
Will the Fed’s announcement that it intends to buy corporate bonds be enough to stop the $10 trillion corporate bond bubble from imploding?
What about the $16-$19 trillion commercial real estate market? Will the shutdown, which has closed so many restaurants and retailers, result in a crisis in this market as businesses begin skipping monthly payments or breaking contracts outright?
And what about the $23 trillion U.S. treasury bubble? Will the $2 trillion in stimulus, which both the President and the Democrats have suggested will be the first of several, be what finally pushes the U.S.’s debt loads into a crisis?
…click on the above link to read the rest of the article…
Despite Massive QE And Congress Bill, The US Dollar Shortage Intensifies
Despite Massive QE And Congress Bill, The US Dollar Shortage Intensifies
How can the Fed launch an “unlimited” monetary stimulus with congress approving a $2 trillion package and the dollar index remain strong? The answer lies in the rising global dollar shortage, and should be a lesson for monetary alchemists around the world.
The $2 trillion stimulus package agreed by Congress is around 10% of GDP and, if we include the Fed borrowing facilities for working capital, it means $6 trillion in liquidity for consumers and firms over the next nine months.
The stimulus package approved by Congress is made up of the next key items: Permanent fiscal transfers to households and firms of almost $5 trillion. Individuals will receive a $1,200 cash payment ($300 billion in total). The loans for small businesses, which become grants if jobs are maintained ($367 billion). Increase in unemployment insurance payments which now cover 100% of lost wages for four months ($200 billion). $100 billion for the healthcare system, as well as $150bn for state and local governments. The remainder of the package comes from temporary liquidity support to households and firms, including tax delays and waivers. Finally, the use of the Treasury’s Exchange Stabilization Fund for $500bn of loans for non-financial firms.
To this, we must add the massive quantitative easing program announced by the Fed.
First, we must understand that the word “unlimited” is only a communication tool. It is not unlimited. It is limited by the confidence and demand of US dollars.
I have had the pleasure of working with several members of the Federal Reserve, and the truth is that it is not unlimited. But they know that communication matters.
…click on the above link to read the rest of the article…
Japan’s QE On Verge Of Failure As Nobody Wants To Sell To The BOJ
Japan’s QE On Verge Of Failure As Nobody Wants To Sell To The BOJ
Over a decade since central bankers started a stealthy nationalization of capital markets by purchasing a wide range of securities from Trasuries, to MBS, to corporate bonds, to ETFs and single stocks, their actions are finally catching up to them, and in the process breaking the very markets central bankers have worked so hard to prop up. And nowhere is this more obvious than in Japan, where the shrinking universe of Japanese government bonds (as a reminder the BOJ now owns more than 100% of Japanese GDP in JGBs) is “causing havoc” in Japanese money markets as the Bank of Japan continues to buy while dealers refuse to sell.
The result is that rates in Japan’s repo market, which traditionally connects holders of bonds with investors looking to borrow them, jumped to a record Tuesday (although they since retreated on Wednesday) because as Bloomberg notes, “the introduction of cheaper, more regular dollar-swap auctions has generated huge demand from U.S. currency-starved dealers who are keeping their JGBs to put them down as collateral.”
So here is what the math looks like now that the Fed has launched enhanced swap lines with central banks such as the BOJ, allowing local entities to obtain dollar funding at much lower rates: in last week’s first round of the Fed’s revamped dollar-swap auctions, banks borrowed greenbacks for about 3-months at 0.37%, a massive discount to the near 2% it would cost them in the currency swap market. $32 billion was alloted in the first operation.
…click on the above link to read the rest of the article…
In Unprecedented Move, Fed Unveils Open-Ended QE Including Corporate Bonds
In Unprecedented Move, Fed Unveils Open-Ended QE Including Corporate Bonds
Coming into Monday, the Fed had a problem: it had already used up half of its entire emergency $700BN QE5 announced last weekend.
Which, together with the plunge in stocks, is why at 8am on Monday, just as we expected – given the political cover they have been provided– The Fed unveiled an unprecedented expansion to its mandate, announcing open-ended QE which also gave it the mandate to buy corporates bonds (in the primary and secondary market) to unclog the frozen corporate bond market as we just one step away from a full Fed nationalization of the market (only Fed stock purchases remain now).
As noted elsewhere, the Fed’s new credit facilities carry limits on paying dividends and making stock buybacks for firms that defer interest payments, but have no explicit restrictions preventing beneficiaries from laying off workers.
Additionally, in addition to Treasuries, The Fed will buy Agency Commercial MBS all in unlimited size.
The Fed will buy Treasuries and agency mortgage-backed securities “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy,” and will also buy agency commercial mortgage-backed securities, according to a statement.
The Fed also said it will support “the flow of credit to employers, consumers and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing.” It will be backed by $30 billion from the Treasury’s Exchange Stabilization Fund.
Coincidentally, this unprecedented action takes place just hours after real estate billionaire Tom Barrack (and friend of Trump) said the U.S. commercial-mortgage market is on the brink of collapse and predicted a “domino effect” of catastrophic economic consequences if banks and government don’t take prompt action to keep borrowers from defaulting.
…click on the above link to read the rest of the article…
The Collapse Of This Historic Correlation Suggests A Major Crisis Is Imminent
The Collapse Of This Historic Correlation Suggests A Major Crisis Is Imminent
A lot of digital ink has been spilled in recent days over the perplexing reversal of the Yen, which for years was seen by the market as a “flight to safety” trade (as unexpected crisis events would prompt capital repatriation into Japan or so the traditional explanation went), only to suffer a major selloff in the past week as it suddenly started trading not as a funding currency for risk-on FX pairs, but as a risk asset itself.
To us, the reversal is far less perplexing than some smart people make it out to be: with Japan now effectively in a recession following the catastrophic Q4 GDP print which crashed 6.3% annualized, validated by today’s just as terrible PMI report…
.. and with Japan now set to suffer a major hit due to the coronavirus epidemic spreading like wildfire across the region, it is only a matter of time before the BOJ follows the ECB and Fed in reversing what has been years of QE tapering, and either cuts rates further into negative territory or expands its QQE (with yield control), and starts buying equities (although with the central bank already owning more than 80% of all ETFs, one wonders just what risk assets are left for the central bank to buy). Needless to say, both of these would have an adverse impact on the yen, and potentially lead to destabilization in the Japanese bond market which for years has defied doom-sayers, but it will only take one crack in the BOJ’s confidence for Japan’s entire house of cards to fall apart. That said, we are not there quite yet.
Furthermore, after the bizarre move in the prior two days, overnight the JPY appears to regain some normalcy, when it traded as it should (i.e., it was once again a risk-off proxy), with the USDJPY sliding during the two major “risk-off” events overnight.
