Original Author: David, W3.Hitchhiker
Since September, risks in geopolitics and financial markets have unfolded successively, and the global market has moved into increasingly unknown territory under the leadership of the Fed's super-hawkish policy. By analyzing the latest moves in three local markets, we may be getting closer to the Fed's turn.
1. The tight liquidity situation of US debt has reached the level of March 2020
In early October, the liquidity problem in the U.S. Treasury bond market entered a new stage: Bloomberg’s indicators for measuring U.S. bond liquidity showed that the tightness of market liquidity has reached the level of March 2020.
In March 2020, when the US Treasury market collapsed due to panic selling, the Fed stepped in to buy bonds as a buyer of last resort. And the current level of liquidity may point to the possibility that the Fed is ready to step in to buy bonds at any time - even if the Fed is currently engaged in so-called quantitative tightening.
"The U.S. Treasury market is the most important securities market in the world and the lifeblood of our national economic security. You can't just say 'we hope it gets better,' you have to Take action to make it better."
The US treasury secretary issued a document on October 11 stating that he did not see anything to worry about in the financial market. He changed his tune a day later, saying "the lack of liquidity in the Treasury market is a concern."
2. Fed earnings start to turn negative
After several rate hikes, the Fed's interest payments have exceeded the interest income generated by its bond portfolio held through QE.
In the past ten years, the revenue of the Federal Reserve was basically around 100 billion US dollars, which was directly transferred to the US Treasury. Some estimates say that the shortfall due to interest rate hikes this year may be as high as 300 billion US dollars (the US military expenditure last year was about 800 billion US dollars). At the same time, due to QT, bond prices have plummeted, causing the Fed to sell bonds at a price that may have to be much lower than the purchase price, which becomes an unrealized loss (non-cash item).
The Fed will not go bankrupt. In the face of a huge hole, it can either ignore it completely; or it can restart money printing.
In short, higher interest rates will only increase the cash burn everywhere within the Fed and Treasury. They will quickly realize that they are completely trapped. They cannot tame inflation without effectively bankrupting themselves. Of course central banks don't go bankrupt -- instead, they may turn in a storm of rate hikes and inflation.
3. "Lehman Moment 2.0" is getting closer
Recently, the market has been turbulent, and Credit Suisse and British pension funds have been in danger one after another.
In the 2008 financial crisis, the transmission of this inter-agency risk was similar to the following figure: During the 2008 financial crisis, the transmission of this inter-agency risk was similar to the following figure:
So after the 2008 financial crisis, is it possible for a new banking crisis to recur?
Before the National Day, several news outlets questioned whether Credit Suisse could herald another "Lehman moment". The "Lehman moment" refers to the collapse of Lehman Brothers, the 158-year-old former Wall Street investment bank, on September 15, 2008, during Wall Street's widening financial crisis. Lehman Brothers was the only major Wall Street bank the Federal Reserve allowed to fail.
At the time of Lehman's bankruptcy, it had more than 900,000 derivatives contracts open and used Wall Street's largest banks as counterparties to many of those trades, according to Financial Crisis Inquiry Commission documents. Data show that Lehman and JPMorgan have more than 53,000 derivatives contracts; Morgan Stanley more than 40,000; Citigroup more than 24,000; Bank of America more than 23,000; Goldman Sachs nearly 19,000.
According to the conclusive report on crisis analysis issued by the agency, the financial crisis in 2008 was mainly due to the following reasons:
“Over-the-counter derivatives contributed to the crisis in three important ways. First, one type of derivative — credit default swaps (CDSs) — fueled the growth of mortgage securitization. CDS were sold to investors, to protect against default or decline in value of mortgage-related securities backed by risky loans.”
“Secondly, CDS were critical to the creation of synthetic CDOs. These synthetic CDOs simply bet on the performance of real mortgage-related securities. They amplified losses from the housing bust by allowing multiple bets on the same security , and help spread them across the financial system.”
"Finally, derivatives were at the center of the storm when the housing bubble burst and crises ensued. AIG was not required to set aside capital reserves as a buffer for its sale protection, but was bailed out when it could not meet its obligations. Due to fears The collapse of AIG would trigger cascading losses across the global financial system, with the government ultimately committing to more than $180 billion. In addition, there are millions of derivative contracts of various types between systemically important financial institutions - in Unseen and unknown in this unregulated market — adding to uncertainty and fueling panic, helping to drive government aid to these institutions.”
Fifteen years after the crisis, do we have similar risks to the financial system?
On September 29, OFR (OFFICE OF FINANCIAL RESEARCH), a subsidiary of the Federal Reserve, analyzed who the bank chooses as the counterparty in the over-the-counter (OTC) derivatives market.working paper, the authors find that banks are more likely to select non-bank counterparties that are already closely connected with and exposed to other banks' higher risk, which leads to connections to denser networks. Furthermore, instead of hedging these risks, the bank increases the risk by selling rather than buying CDS with these counterparties. Finally, the authors find that common counterparty exposures remain associated with systemic risk measures despite increased regulation following the 2008 financial crisis.
To put it simply, once a systemically important bank fails, the financial system will still have a systemic chain reaction like in 2008.
So, does the Fed need to turn around like the Bank of Japan and the Bank of England?
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