Zoltan Pozsar on What’s Going on in Rates Markets Right Now

Tracy Alloway (0:11)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My cohost, Joe Weisenthal, is away this week.

I am recording this on September 1st, which means it is the start of a new quarter. And whenever we have the start of a new quarter, it's usually a time to start reflecting on what's happening in money markets. And there has been a lot happening in money markets so far this year. So, you know, just today we have 82 participants placing $1.19 trillion at the Fed's reverse repurchase agreement facility, the reverse repo facility. And I have to say, the US financial system right now is kind of a wash in liquidity, and it has been for some time.

And that's causing problems for banks who have to handle all these deposits, problems for money market funds, and of course problems for the Fed. So all this liquidity means that money market rates have basically been pressured lower all year, so much so that the Fed has actually had to tweak some of its facilities, including the reverse repo facility back in June, to prevent those rates from going even lower. And more recently, it surprised the market by introducing a standing repo facility. So we have had a lot of requests to talk about this on Odd Lots, and no surprise, we've had requests to speak to one person, in particular, a repeat Odd Lots guest. We're going to be talking to Zoltan Pozsar, of course, the global head of short-term interest rates over at Credit Suisse. Zoltan, welcome to the show again.

Zoltan Pozsar (1:59)

Thank you very much for having me back.

Tracy Alloway (2:02)

So I'm trying to think where to start, but maybe you could begin by describing the general state of liquidity and money markets at the moment. Like when I say the financial system is a wash in liquidity, what exactly do we mean?

Zoltan Pozsar (2:20)

The general, what is the general state? The general state is things that haven't happened before are now happening. So again, let's perhaps start with the frustrance basis. This is something that we are used to as being very negative. There's always an excess demand for dollars and that excess demand for dollars is gone. The cross currency basis is pretty much closed. You have some jurisdictions, smaller countries, but the cross currency basis is even positive. Mexico, South Africa, in China, these are quite unusual things.

LIBOR is dormant and the basis to OIS is three basis points, very tight. Repo and bill yields are very low. And what this is a reflection of is naturally just too much cash in the system relative to the demand for this money.

I think unfortunately, I think we are in a period where things are going to be very different for quite some time relative to how things were over the past five years. I think over the past five years, we've had sort of a golden era for stir traders because we've had so many spread moves in the money markets.

The LIBOR basis or the cross currency basis has done, the repo markets acted out in the past. But if you think about why liquidity was tight as opposed to abundant, they're basically three reasons. The Fed stopped QE in 2015, and then the ECB and the BOJ were just starting. So we were in this position where there was an excess supply of euro and yen. People didn't know what to do with it. So they spot it for dollars. So that drove that specialness, the dollar in the FX stock market.

Then we had Basel III that was getting rolled out. And so nobody understood that, right? So you had this relative shortage of dollars combined with an ever growing shortage of balance sheet for various parts of Basel getting rolled out.

LCR, SLR, the GCEP scores. The banks themselves had to learn how to manage these ratios. The market learned how to trade these ratios.

And then we had these little idiosyncratic things like money fund reform, corporate tax reform. And so these were always banking things around. Some of the most experienced third traders will tell you that they've never traded as much front end basis in their career. You know, some of those careers spent 30 years as they did between 2015 and 2019 And so then you fast forward to today.

We now have so much liquidity. And this is particularly a case for the US dollar that the Fed is doing QE faster than the BOJ or the ECB. So there's just an ample supply of US dollars. Regulations are not getting tighter. If anything, they are getting easier. The Fed has become a dealer of last resort. We have the swap lines. We have the standing people facility for banks. We have the standing people facility for foreign central banks. So this is a very different environment. And then in the midst of this, a lot of liquidity, a lot of balance sheets, a lot of excess cash in the system. There's also not as much activity in the world economy that needs to get financed. So if you just think about why foreign banks elsewhere, borrow dollars, because they need to finance trade flows or what not. So debt demand is dormant. I think capital flows are a bit more domestic. You know, the FX hedge flows are not as dominant as the relative value hedge funds are kind of checked out at the moment because there's not a lot of opportunities. And so, you know, there's, and you know, the best reflection of all this excess cash, as you mentioned, is all this $1.2 trillion of cash that's sitting in the reverse repo facility, which you literally want to think about as money the system doesn't need either because it doesn't have the balance sheet for it or because there's no use or outlet for that money.