Repo, USD liquidity
Special column in this issue: US dollar liquidity from the perspective of repurchase capital demand. The repo market is a bridge between the U.S. bond market and the currency market, and an important window to observe the liquidity of the U.S. dollar. Primary dealers are an important medium in the repo market, and the market capital demand and liquidity level can be tracked through the reverse repo and repurchase situation of primary dealers. Interest-bearing U.S. bond issuance will pick up significantly from the second quarter, and the demand for reverse repo (financing) from primary dealers is likely to grow, and the marginal tightening of funding is expected. In addition, hedge fund basis trading may also lead to marginal upward movement of SOFR rates.
The Fed's March interest rate meeting was dovish, but the strong non-farm payrolls data since then has led many Fed officials to believe that interest rate cuts should be postponed this year, and the Fed's internal policy divergence has widened. The BTFP expired on March 11, but the discount window and buybacks have not increased significantly in the near future. In March, the demand for domestic US dollar lending and repurchase rebounded significantly, and the volatility of capital sentiment was amplified. The growth rate of foreign exchange deposits of domestic financial institutions was -6.3% year-on-year, and the recovery momentum slowed down. Overseas US dollar liquidity is generally stable, and the central banks of Europe and Japan use the Federal Reserve's currency swap agreement.
Special column in this issue: US dollar liquidity from the perspective of repurchase capital demand
In the U.S. Treasury market, both directional position holders and basis traders generally use dealers for financing. The repo market is a bridge between the U.S. bond market and the currency market, and an important window to observe the liquidity of the U.S. dollar. The U.S. repo market can be divided into four categories according to the criteria of clearing, non-liquidation, tripartite and two-side, among which non-clearing bilateral repo is the type of repurchase with the highest proportion, but its data is very opaque.
Regardless of the type of buyback, primary dealers are the most important medium of the market. Daily financing is now available through the New York Fed's primary dealer survey data, and the total size of repurchases, the size of the four types of repurchases, and the types of securities pledged as of last Wednesday are published every Wednesday. In terms of the types of securities, U.S. Treasury bonds are the most important collateral, followed by institutional MBS. In the survey, "reverse repo" refers to the primary dealer buying securities and raising cash, and "repo" refers to the primary dealer mortgaged the bond and incorporating cash.
SOFR measures volume-weighted GC repos collateral and FICC cleared DVP bilateral repo swap rates. However, due to the fact that primary dealers have only started to release the breakdown data of different types of repos after March 2022, at present, only the balance of reverse repo (financing funds)/repurchase (integrated funds) and reverse repo / reserve balance of US Treasury bonds can only be calculated based on the aggregate data since 2013 to reflect the relative level of capital demand and capital supply in the treasury repo market. At the same time, the SOFR-IORB spread reflects the liquidity of the U.S. Treasury repo market. It can be found that when the reverse repo/repo and reverse repo/reserve balance account for a relatively high proportion, it often corresponds to an upward interest rate spread. Historically, when the reverse repo/repo is greater than 0.89 or the reverse repo/reserve balance is greater than 0.68, the SOFR interest rate is prone to rise abnormally. In the first quarter of this year, the pace of issuance of U.S. bonds was slow, and most of them were Treasury bills, and the repo market was loosely funded. Interest-bearing U.S. bond issuance will pick up significantly from the second quarter, and the demand for reverse repo (financing) from primary dealers is likely to grow, and the marginal tightening of funding is expected.
In addition, it should be noted that non-clearing bilateral repo accounts for 50%~60% of the reverse repurchase of primary dealers, which is the most important way of financing. At the same time, non-liquidated bilateral buybacks are also an important financing method for hedge funds. According to FICC statistics, it accounts for more than 90% of hedge fund buyback financing. We have previously described the symbiotic relationship between basis trading in hedge funds and longs in US Treasuries[1]. In short, as the U.S. economy recovers, credit spreads continue to decline, attracting actively managed funds (asset managers) to increase their credit exposure to outperform the benchmark, while opening long positions in the U.S. Treasury futures market to control duration, resulting in a sustained premium to U.S. Treasury futures over cash. Hedge funds take short positions in Treasury futures and long positions in cash bonds to earn spreads. The signs of a soft landing for the U.S. economy are becoming clearer, and credit spreads still have some room to decline from historical lows. The long position of U.S. Treasury futures held by asset management has been reduced in February and March, and the short position of hedge funds has also decreased accordingly, which may correspond to the reduction of credit exposure of asset management. However, after credit spreads further break through the previous platform, asset managers may re-increase their credit exposure, which in turn will also need to increase their longs in U.S. Treasury futures. Correspondingly, hedge fund basis trades are likely to expand again. In this way, the proportion of non-clearing bilateral repos in primary dealer repurchases will also increase. Given macro liquidity, this will squeeze funding sources for other types of buybacks, widening SOFR spreads. The current data released by primary dealers on non-cleared bilateral repurchases began in March 2022, and within a limited sample, the proportion of non-cleared bilateral repurchases also showed a certain correlation with SOFR spreads.
1. Fed tracking
The wording of the Fed's statement at its March meeting was barely revised. In terms of quarterly economic forecasts, the Fed raised its growth forecast for 2024-2026, lowered the unemployment rate for 2024 and 2026, and raised the PCE for 2024, 2025 and core PCE for 2024. The median interest rate will remain unchanged in 2024 and move up in 2025, 2026 and long-term interest rates. From the point of view of the distribution of the dot plot, the committee members expect the rate cut to converge to the range of 0-75bp during the year, and the mainstream expectation is 75bp, which is basically consistent with market expectations and has moved up from the convergence of the dot plot at the end of last year. At the press conference, Fed Chairman Jerome Powell said that it will be more difficult for inflation to cool in the second half of the year due to the low base in the second half of last year. Confirmation of the data is needed to give us enough confidence to see inflation come down in real terms towards 2%. It is believed that inflation is gradually bumpy to fall back to 2%. There will be no overreaction to inflation data from the last two months, but neither will the data be ignored. Strong employment in itself does not constitute a reason to prevent interest rate cuts. The job market also does not pose a concern about inflation.
In terms of official rhetoric, the Fed's attitude towards interest rate cuts is divided, with hawks including Governor Bowman, Dallas Fed President Rogan, Minneapolis Fed President Kashkari, and Atlanta Fed President Bostic, who generally believe that interest rate cuts need to be delayed or even not cut this year. Doves including San Francisco Fed President Daly and Cleveland Fed President Mester remain unequivocally in favor of three rate cuts this year, while New York Fed President Williams reiterated that interest rates will be cut later this year. Fed Chair Jerome Powell was slightly more hawkish, saying that he would only cut interest rates if he needed to be more confident about inflation.
In terms of the use of liquidity instruments, the temporary liquidity tool BTFP expired on March 11, and the discount window and the use of repos have not increased significantly in the past two weeks, reflecting that liquidity remains stable. As the U.S. Treasury increased the issuance of interest-bearing Treasuries, net issuance of Treasury bills turned negative, and the rate of decline in overnight reverse repos slowed.
2. Domestic USD liquidity
In terms of onshore USD interest rates, the 3M USD CIROR interest rate and swap implied onshore USD interest rate in March were basically the same as at the end of February, the SOFR and USD Libor interest rates were flat, and the onshore and offshore USD interest rate differential (offshore-onshore)[2] stabilized and did not further narrow. A-shares continued their rebound in the first half of March, but gradually fell into volatility in the second half of March. Funds remained net inflows, but the scale of inflows fell from the beginning of the year. USD/CNY broke out of a narrow range and volatility recovered. However, the median price remained below 7.10, releasing a signal to maintain stability.
In the domestic dollar market, the demand for US dollar lending and repo rebounded significantly in March, and the sentiment of capital A was amplified compared with February.
US Dollar Call: US dollar lending demand rebounded in March, increasing from US$471.2 billion to US$606.9 billion. In March, the interbank dollar lending fund sentiment index continued to fluctuate at 50, but the market sentiment fluctuations during the month were significantly larger than those in February.
USD buybacks: USD buybacks increased significantly in March, from $23.4 billion to $38.7 billion.
Certificates of Deposit in US Dollars: A total of $500 million in certificates of deposit matured in March. HSBC (China) and China CITIC Bank issued 1 and 2 US dollar certificates of deposit respectively, with a total issuance size of US$1.9 billion.
US Dollar Deposits and Loans: As of February, the total foreign exchange deposits of financial institutions were US$828.8 billion, and the total foreign exchange loans were US$673.2 billion. The year-on-year growth rate of foreign exchange deposits of financial institutions was -6.3%, and the year-on-year growth rate of loans was -10.4%, and the recovery momentum slowed down.
3. Overseas USD liquidity
The SOFR, FFR, OBFR spreads quickly retreated after a brief seasonal rebound at the end of March, while the LIBOR-OIS spread remained in a narrow range. In terms of the use of currency swap agreements between non-US mainstream central banks and the Federal Reserve, the European Central Bank (ECB) has maintained its use at about $200 million per week, the Bank of Japan has increased its use to $8 million at the end of March, and other central banks have not used swaps in March.
Note: [1] For details, see the "symbiotic" relationship of the U.S. Treasury futures market - U.S. Treasury Monthly Update 2024, Issue 2, February 2, 2024. [2] The onshore and offshore USD interest rate differential (offshore-onshore) refers to the 3M SOFR rate - the 3M swap implied onshore USD rate.
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