15/03/2020 – The Fed’s Corona Cut


That was unsurprisingly surprising…

The Fed just cut by 100bp to 0%.

They’ve really just showed their hand here.

They’re running extremely scared.

And the worst thing?

There’s still the FOMC meeting coming up on Wednesday!

Could they possibly go negative here?

Well, we’ll see what bonds are saying tomorrow…

My thoughts are that they certainly could.

I’ve been saying for a long time that I was expecting rates to revert back to the upside…

That would have held true if there were not such a large tail risk such as this virus that came to play.

Now, I think the feedback onto growth prospects are too great to make that a valid proposition right now.

Goldman Sachs have downgraded US growth prospects…

-5% growth!?

Oddly, they expect a rebound in Q3, which, judging from the responses from governments and central banks, I find hard to see happening.

Most notably from this, however, has been the expansion of the dollar swap lines.

What are swap lines?

These are agreements where central banks look to keep liquidity available in a specific currency to lend to private/commercial banks in order to maintain reserve requirements.

The specifics here are that they have enhance their dollar swap lines by making it cheaper for central banks to utilise this liquidity from them by affecting the OIS (overnight index swap).

They’ve lowered this by 25bp to +25bp.

The maintenance of reserve requirements is supposed to allow for credit to flow more freely through the economy.

Right now, there are still funding issues with the dollar – it’s relatively illiquid, which shows us that there are some stresses in the interbank lending market.

This action by the Fed is there to attempt to alleviate this.

However, it just makes me ask the question, ‘who is f*cked?’

You’ll know I’ve been speaking about Unicredit recently, but since the enhanced swap lines have been opened up to the BoE, SNB, BoC, BoJ simultaneously, I’m concerned that they are worried about a seizing up of credit globally…

But, the main focus here should be on European banks.

But again, I can’t help but focus on Italy.

See, swap agreements in this fashion work like this.


Key is point 3.

In 2007/08, we didn’t have a virus that was causing countries to shut down.

We didn’t either still have the effects of the crisis causing a hangover…

On top of that, we didn’t have the papering over the cracks from a regulatory perspective that we have now.

Again, I want to refer to Italian BTPs and the extent to which these are held at Italian banks with a risk weight of 0.

For me, these remain a massive risk, and especially so now since there has clearly been some realisation that liquidity is the issue (or at least, a major issue).

I tweeted this thread the other day…

Behind the facade of the joke, I was very serious.

I have believed there to be an issue with liquidity for a while, and this issue having stemmed from the actual liquidity regulations themselves (Basel 2 & 3)…

The demand for these swap lines is showing that now.

Check back through the archive to a few weeks ago for a reminder of Unicredit’s BTP risk.

Currently, the futures markets aren’t buying any belief that this is a good thing.

We’ve already hit limit down and as of writing, we aren’t even an hour into the session…

And imagine – a big brained person called me stupid for not wanting to hold risk into the weekend!

For those of you that are new here, you have a great opportunity to maybe exploit a trade that the others have been for the last year.

For those of you that aren’t new, you know what that trade is – selling AUDJPY more.

New people…

This is a great way to take advantage of risk without playing it through equities indices.

But also because the uninformed traders have been trying to long this consistently for the past year.

And currently, retail are sitting at a 80% long position…

It is important that you do follow the risk management framework mentioned in the introductory email, however.

As well as this, if we are seeing a deteriorating credit risk profile of Europe, we want to be selling EURCHF as well.

I strongly doubt that we shall be seeing SNB intervention to the extent that CHF strength overrides the fundamental weakness of the Euro area and I think this will be maintained even into the midterm timeframe.

For now though the big risk is the Coronavirus and what that will do to liquidity.

My thoughts are still that this will not cause a massive loss of life, but the response to it is likely to cause economic pandemonium as we are currently seeing…

As well as the excuse for central bankers to do as they are doing currently.

PS – don’t forget the 75bp cut the RBNZ undertook just before the Fed this evening 😉

Any questions, just hit reply or mention me in the general chat section of the Discord.

And please, stay safe.

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