Thursday, September 15, 2011

What Euro Dollar funding crisis?

But first, what a difference a phone call makes.
  1. Germany and France put in a "catch up" to their pal Papa in Greece and tell the world that they told him that they are right behind him.
  2. The Letch makes a "tell it like it is" call that mentions Mangler and is overheard.
  3. A UBS trader makes a couple of calls which result in a final one to his imminently ex-boss involving the words "HOW MUCH?????" being screamed a lot.

To which the market is replying:

  1. "Oh good, that's all sorted then. Can I now buy Greek debt yielding over 100%?".
  2. "Ooohh... he's a one isn't he!".
  3. "Jeez, that's not good. I'd better shut down my risk just in case I haven't dotted an 'i'."

But TMM is thinking:

  1. Is that Timmy G's voice in the background? This should be enough to divert the attention of the attack dogs long enough to focus on other market things. Isn't Aussie looking sick!
  2. Its always been hard to prove that Berlusconi has lied.
  3. We wish we were forensic auditors, demand is about to go through the roof again. Oh gawd, we are going to have Vince Cable on every media outlet crowing his 'told-you-so-evil-bankers-turn-them-all-into-village-post-offices-staffed-by-sweet-old-ladies' mantra. Also, rogue trader announcements have uncannily marked market turns (Leeson and Kerviel).

There has, however, been one phone call made that makes no difference at all:

"Hello Mr Osborne. This is Dr King. Mervynflation and our expectations thereof are running like Usain Bolt on speed, but as policy bias appears to be moving from monetary to fiscal, it's not my problem and I suggest you raise taxes".

Now then, on to something that has been sticking in the craw of TMM for some time and has them jumping up and down in frustration every time a headline on European funding is waved in front of them as example of "the massive US$ funding crisis that European banks are suffering". The sheer frenzy that journos and punters whip themselves into reminds them of this scene.

TMM reply "there isn't a funding crisis - there are more dollars floating around than you can imagine" and here we put our case as to why and try to debunk some of the recent hysteria over "funding" headlines, messages, emails and cut n pastes from the "Hero Zedgers" that appear to confuse simple issues. We want to clear a few things up.

Forgive us for starting with old material, but for completeness, in the early days of the crisis, as USD funding markets shut down, leveraged institutions in Europe and elsewhere were forced to use the FX Forward market to borrow Dollars in significant size, driving the Cross-Currency Basis sharply negative. In the case of EURUSD, this basis is the difference between exchanging a stream of US 3m Libor coupons and a stream of EUR 3m Euribor coupons, and is quoted as the number of basis points deducted from the 3m Euribor stream. If 3m Libor and 3m Euribor were both riskless and there were no relative liquidity preference for USD over EUR, then this difference would be ZERO and the FX Forward would be priced as the difference between the two deposit rates. However, that is the world of textbooks, academics and arbitrage, something TMM have rarely found to be useful in their careers. But we digress, the point here is that the more negative the basis moves, the more people are willing to pay for USD through the FX Forward market.

Since 2008/9, cross-currency based funding has reduced significantly as banks and hedge funds de-levered their balance sheets, and the advent of QE led to the explosion of the Fed's balance sheet and a sharp increase in the excess reserves of foreign banks' US subsidiaries accounts with the Fed. This means that cheap and abundant USD funding has been available to those large international banks lucky enough to have an account with the Fed, but smaller ( and usually peripheral European banks) in need, have usually had to utilise the FX Forward market to borrow dollars.

With the European situation deteriorating, the 3m Cross-Currency Basis (see chart below) has once again moved sharply negative, but in contrast to 2007-8, TMM's mates in the forward market report more USDs than pieces of Lego in the overnight and tom/next markets, while term prices are moving largely on the back of broad-based risk aversion. This is an important point - early on in the crisis, FX Forward and basis markets were a leading indicator of trouble precisely for the reason that such large funding exposures had been built up in the 5years prior. This just isn't the case anymore. By early-2009, the large part of bank cross-border funding exposures had been unwound as European banks sold EUR/USD in order to pay down the losses on those US assets. And, as above, central banks have provided significant amounts of liquidity and liquidity back stops in the form of FX Swap lines - simply put, the amounts traded in this market just aren't that large anymore, because generally, banks do not need to tap it for USDs.

Yesterday, TMM's IBs lit up in excitement at the ECB's USD Auction Allotment showing that two banks had borrowed the princely sum of $575m from the ECB. The below chart of the facility's usage should put this into perspective. Today's ECB marginal lending facility showed a jump to EUR 3.4bn borrowed, from the usual few hundred million a day. More excitement. I don't think anyone would be particularly surprised that a few peripheral banks might be having a tiny(!) bit of problem funding, and were forced to go to the ECB facility to pay 2.25%. But let's be realistic- versus assets earning yields of 5% or more, this is hardly going to force them to go bust. But that is a different point entirely. TMM's main point here, is that this number often bobs up and down because of technical factors such as:

  1. A missed payment from a counterparty for a number of reasons ranging from human error to IT systems issues.
  2. Someone not accessing the ECB's MRO in enough size and thus being forced to pay up for funds.
  3. Someone getting their funding calculations wrong (TMM have seen it happen first hand) and it being too late to rectify by the time they realised this.
  4. An unexpected late day payment.

This stuff just happens, it is not unusual. Of course, were the amount to move rapidly higher then it would certainly signal something more serious, but as of now, TMM are unconvinced.

Next, while historical data for European CP issuance in the US is sketchy, due to the primary nature of the market, as a proxy, the below chart shows 30day Natixis Commercial Paper, which should be a reasonable approximation to the rates that European banks are paying directly on CP in the US. It has certainly moved higher over the past two months, but as a reality check, 0.45% for one month unsecured money is hardly a sign of severe funding stress.

As a comparison, the below table shows the current implied US $ funding rates from the FX Forward Market vs the ECB $ Auction and the above direct US $ CP issue assuming different rates of Euro funding - unsecured (Euribor), EUR Repo market, EONIA, the ECB's 7 day MRO, the LCB's LTROs and the ECB's main refinancing rate. The ECB $ Auction works out to be about 1.1% (1week US OIS +100bps), but in reality is a bit more expensive than that due to the need to post collateral for the 12% haircut. The point below is that generally, market Dollar funding costs are just not high enough for banks to need to tap the Fed/ECB swap lines, with only the 3m Euribor-based rate being really higher than the ECB auction rate.

Graphically, looking at the 1M implied funding rates, it's not really obvious that these are particularly extraordinary, and only at the kind of levels seen last December. The Orange line shows the rate implied from Euribor, the yellow line implied from the ECB's LTRO, the whte line implied from Eonia, the green line implied from Euro repo and the pink line the Natixis US CP rate. The chart makes clear the distinction between unsecured borrowing in Europe and swapping it (orange), and accessing the ECB's LTRO and swapping it (yellow) and the secured repo-based borrowing (green) and the better-quality banks that are still able to access the Eonia market (white line) and US market direct (white line). As we have hit the level at which it is becoming attractive to access the ECB's US $ Auction facility, TMM would not be surprised to see the allotment here move higher should current market rates prevail, but would not read anything into it other than the fact that it may well be cheaper to tap than the market itself...

A slightly longer term chart:

Unless the allotment spiked dramatically into tens of billions of Dollars TMM does not think there really is a Dollar funding crisis in Europe.


Anonymous said...

C says'
Don't let the facts get in the way of emotion (until I have finished buying). Indeed I have an anonymous source that assures me you are receiving a commission from the National Association of (W)Bankers to assmeble and release this market distorting stuff ! You are sir,in the pay of "them" ,"they","the world order" ,so be off with you sir !

Thanks for the data and the analysis.

Charles Butler said...

You can half understand why politicians are so loathe to act decisively if this is typical of the problem that needs to fixed. Can you imagine policy that had reacted in a rapid and timely fashion to every theme du jour of the last four years?

Here's an effin' beauty that showed up yesterday. Originally from the Millionth Monkey (aka Hero Zedge), it was picked up by Ritholtz - that grand defender of the common man's right to know - and that sanctimonious pink blog, though they had enough shame not to post the table.

Keep up the good work, kids.

Anonymous said...

C says'
As there ever been a time when the sheer breadth of 'noise' in terms of opinion,rumour etc etc was greater and does anyone have a theory about how this impacts sentiment (in both directions)?
The internet has alot to answer for because it was bad enough when the 'noise' channels were just a handful of papers and TV channels ,but now the pipeline has mushroomed in size so that evn the guy cleaning the public toilet get's to tell the world what they guy form RBS was reading when he wa taking a dump.

Anonymous said...

excuse the language of course,but this is an issue I've been getting frustrated with for awhile !

VandalsStoleMyHandle said...

Nice post; I've been harping on this point for a while, but this says it much more eloquently; I think I'll print this out, stick it on a 2x4, and start hammering people over the head with it the next time I hear (Chicken Little voice...) 'the basis swap...the basis swap'.

The other semantic fraud in this line of reportage is that banks tapping swap lines or whatever does not mean that banks are in means banks would be in trouble in the absence of the swap lines. The swap lines precisely prevent banks getting into trouble via this channel...but of course 'NIM compressed by swap line useage' doesn't seem quite as sexy a story to ZH or FT Alphaville....and then there's all the BS about 'stigmas'...faark.

One other point is if these funding needs intensify, the possibility exists to cut the swap line rates quite dramatically; the current premium being somewhat draconian.

Anonymous said...

Broadly agree with this, however I would add that what is happening is that accounts are cutting lines to sub 1 month. Most European banks can only borrow US domestic dollars for 1/2 weeks.

Eventually, the amount of paper rolling becomes untenable. There are also local regualtor implied term funding metrics as well, some non-US commercials may start to run into problems.

Ultiamtely bank treasurers are sick of the senior unsecured costs and will now be telling the source of their funding gap (the IB division!) to cut their balance sheets.

ntwsc said...

This is turning into a thankyou fest, but thank you!

Please feel free to expound on any other matters that have you jumping up and down with frustration (SFWCPS?).

And yep CfC, the FFF syndrome has been honed to a fine art from famous for fifteen to five.

CV said...

Very interesting TMM, I must admit that we have been beating this drum quite a bit in our own research publications but this makes me think twice ... which is always good.


gerard said...


I am quite new here and I am also adding my thanks. ;)

Here is a link that may interest you :

US banks privately lending billions to support European lenders

See ya ;)

Leftback said...

As is often the case, the imminent demise of certain institutions has clearly been exaggerated. It is hard to see how there could be a prolonged shortage of dollars anywhere in light of FOMC policies since 2009. Now, right on cue...

ECB to Lend Dollars to Euro Area Banks

Let's add a few more acronyms ...?

UBS = unbelievably bad supervision?
BNP = Bought naf paper.
NBoG = No Bars of Gold

We will have fun texting our mates at UBS today to see if they have looked under their desks, chairs, etc. lately. Lost anything, etc..? Too funny - and of course it would be rude not to.

Leftback said...

US data not very good, Empire State etc.., but that means an easy Fed - so party on, right? Quad witching tomorrow, today might get a little weird in NY.

Mr Shorty clearly in a spot of bother over in Europe today. The DAX 5500 level is in play here as it now forms resistance, used to be support. Likewise SPX 1200. We are inclined to curb our exuberantly bullish punting from the long side a little today. It has been a good week!

Leftback said...

Goldfinger and Mr Bond are fighting in the plane again. Only today both of them are going out of the window!

Goldfinger v Bond

Anonymous said...

im guessing the FED/ECB and the rest of the CBs involved thought there was something to the "$ funding issues".

or am i wrong?

cpmppi said...

Anon @ 3:15,

We would view this as an "easy win" for policymakers, given that it didn't actually require any effort to execute, and will act as a backstop going forward to calm irrational fears of funding worries.


Anonymous said...

cpmppi @ 331,

I second that. Much better to throw your weight around as a CB before things are out of control, trading into the trend so to speak. Reminds of the IEA getting behind the downtrend in oil off the April highs.

Today's US data wasn't very reassuring, but should we be surprised that the 'real' economy pulled in the horns this summer while watching a political train wreck and the 'confidence fairy' disappear? I'm not so sure. And as Mr. Rogoff teaches us, we should expect huge volatility and swings in the data, as we all swing from euphoria to fear post-crisis.

CV said...

Indeed LB, the short-Europe punt is getting a bit of a cold fudge bath today. And my oh my does them banks go when they go. What was the high print on BNPP, 22%? Of course ... no short sellers there ;)


Anonymous said...

C says'
22% shows just how much weight had gone short on this and prbably banking in general and they cut each others throat trying to get to the tune of 22% ...not inconsequential.

Charles Butler said...

Claus - there may have been no short sellers, but there sure were a lot of short positions the owners of which certainly thought were a rare and irreplaceable asset. Seems they didn't get the SNB's message that the game being played was no longer badminton.

Looks good on all the lot that didn't cover when the WSJ initiated the passing of the BNP bag on Tuesday.

euro bear said...

My bottom hurts.

Leftback said...

Getting a bit more cautious here - if we don't burn through DAX 5500 or SPX 1200 before the weekend. Most of the shorties have already been incinerated. So we will bid adieu to some of our index longs.

"It was great fun, but it was just one of those things...."

Leftback said...

Whining bears abound, love this stuff:

"In hindsight, this action by global policymakers was predictable and was indeed predicted by Morgan Stanley's global economics team last week, among others."

Well, yes. They did say they were going to.

"Meanwhile, the Dow Transports had risen 10% and the Nasdaq was up 5% in the prior two day, leading some market participants to speculate "someone" knew this moving was coming."

Ooooh... mainpulation.. evil market players !!

"Between the government taking these actions and a market that moves before the news, we are living inside a giant insider trading machine," writes Scott Bleier of Create Capital."

LOL. We are thinking that Scotty didn't "create" much capital today b/c he got Edward the Seconded.

For goodness sake, Scotty Dog, they TOLD everyone LAST WEEK that if you kept shorting, they were going to SPEW LIQUIDITY from every orifice. We even warned you all, right here at MM, to get your anoraks ready before they started.

Silly sausage.

abee crombie said...

nice post.. funding might not be that tight but it is moving in the wrong direction. would like to see it turn the corner before going long in bank stocks but of course you will be late to the party by then.

I love how no news out of europe is considered good news. Has anything changed at all since last year? 3month loan offere, really? thats been around for ages. Head in the sand and hope it ends up well.

Hopefully the eurocrate figure out an orderly default / restructure and a massive backstop for everyone else so the world can go on, but I think they will only do so if pushed.

Amplitudeinthehouse said...

Just thinking , this may tie in nicely with our ref-darkmatter threshold zone chart( remember the no-mans-land) Yep.....slick showing the way now, must be those correlation trades, at this stage the ref is lagging (badly) but ,after reading this its no wonder.So if the real catch up is the fin-razzes catching down then watch out this is going to go fast.

Marcf said...

Interesting post and comments.
1/ There was a funding crisis. Most of the people I know from BPNSG were saying so last week
2/ I am still thinking through the data you showed but a clearing price at the ECB swap rate just shows that there is a crisis. If there wasn't it would stay low. If there is it will stabilize right above the ECB price, almost by definition
3/ I don't think there was stigma here
4/ because very frankly I (personally) suspected foul play by some US players. There was a sudden and coordinated shortage of liquidity
5/ which was silly because we all knew the liquidity swaps were in place at the ECB/FED and as soon as the last graph you showed went to the clearing price it would, well, clear with ECB involvement
6/ so let's get this straight: there was a crisis but it would never go very far as the ECB would TALF (EFSF) the banks like the US did (see this morning FT).
7/ Someone made a lot of money on the way down and the way up

Anonymous said...

jpm's panigirtzoglou would somewhat disagree with your title, on the dramatic fall of volume of us cp/cd issuance since may