Wednesday, August 10, 2011

Is the Credit Crunch Crunchy?

If you have some experience in funding markets, repos, etc your input here is very, very welcome. E-mail me if you could add to this analysis. Thanks a lot.

[Yes, today I heard rumours that american banks were pulling Repo Lines from SocGen]

Yesterday we posted on Twitter that some interesting market movements in short-term ED futures was in place right after Bernanke guaranteed cheap money for 2 years.
In minutes (or seconds?) the EDZ1EDZ2 3m USD Libor spreads collapsed form around 20bps to negative territory and as the risk markets recovered and shot upwards moved alongside.. closing back above 0.

Today it is now back in negative terrain.


The Fed Funds rate is around 6-10bps, 30day average of 8bp.
The current 3m USD Libor fixings are around 25-28bps.
And the spread between, all 3m USD Libor, Dec11 fwds and Dec12 fwds is @ -4bps, after reaching -6bp intraday.

What does this mean?

Possible scenarios:
(A) Considering that the 3m USD Libor has a high correlation AND beta to the effective FF rate, people believe the Fed will increase its FF rates soon enough (before Dec11), but will later have to cut the rate again during 2012.

(B) People are betting that the 3m USD Libor will actually be lower than it is today (with Dec11 equal to today).

(C) People think short-term corporate/banking rates (interbank funding markets) will freeze, as it happened in 2008, and short-term funding costs will explode with banks and shadow-banking-system going bust.

(D) Someone long this spread in huge amounts (or somehow affected by these 2 maturities in ED futures) is being squeezed and liquidating its position against market rationale.... at negative fwd rates even with base rates very close to 0.00%-0.25%.

Now the probabilities:

(A) NO: The Fed just said it will keep rates at 0%-0.25% until Mid-2013. So.. No. Won't happen (not even considering bad economic fundamentals here).

(B) NO: There isn't a lot of upside for receiving rates here if you consider that the Dec11 rates will remain equal to the 3m spot of around 28bps now. Upside would be gaining a maximum of 0.00% - 28bps and the downside is just massive. There are bad portfolio managers and heads of repo and treasury desks out there.. but, hey, come on!

(C) Yes? People have in mind (or already know that some repo lines are being pulled?) that there is a credit crunch coming and, with Bernanke guaranteeing zero-rates forever [reason for a steep curve], there's little downside risk to betting on that: short-term rates exploding, but falling back to normal levels after there's huge liquidity injection and central bank guarantees from all major central banks world-wide (TARP2, USD swap lines, etc...)

(D) Amen.

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

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