Intraday Market Thoughts

Systemic Risks are here

by Adam Button
Mar 12, 2020 23:50

And it finally happened; major US indices fell 10% in a single day, the biggest percentage drop since the October 1987 crash. Coronavirus is illustrating how quickly a real-world crisis can morph into a financial one. The Fed's emergency liquidity-creation move, return to QE and the enormous losses in markets suggest mounting stresses.  The US dollar was the top performer on the day while the pound lagged. The GBP and Bitcoin trades were stopped out. A new Premium video has been posted below, highlighting the core of our high-confidence trades.

A major theme in the post-financial crisis era in the markets has been the mass expansion of liquidity. The risk is that liquidity has turned into leverage and the breathtaking speed of the declines in financial markets have pushed parts of the system to the brink.

The emergency move from the Fed today was ominous. Five minutes before a 30-year bond auction the Fed announced a $1.5 trillion term-lending program. To put that into perspective, after two years of QE in 2011, the total size of the Fed's balance sheet was $2.1 trillion. Moreover, the Fed announced that in just 35 minutes it would be auctioning $500B of that with a same-day settlement.

That final detail is key. A same-day settlement suggests someone needed money asap. Financial institutions need to balance the books at end-of-day and needed to unload liquid assets to avoid dumping illiquid ones.

The Fed itself said this was due to short-term Treasury market liquidity issues and that also appears to be true. Spreads were widening and the cross-currency swaps market wasn't operating correctly. Given the rout in European banks, that suggests problems could be there.

Of course, this is all speculation. The larger point is that we are all currently focused on the direct impacts of the virus and trying to quantify and mange those but there are a series of second-order effects that could completely break a market that's already on its knees. The combined opacity of that and the extreme unknows surrounding the virus justify the extraordinary levels of risk aversion we're seeing and the continued flows into the safest havens.


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