Treasury

From the Vault: A Look Back at the October 15, 2014, Flash Rally

Published by Anonymous (not verified) on Tue, 15/10/2019 - 10:00pm in

Tags 

Treasury

Michael J. Fleming, Peter Johansson, Frank M. Keane, and Justin Meyer

 A Look Back at the October 15, 2014, Flash Rally

Five years ago today, U.S. Treasury yields plunged and then quickly rebounded for no apparent reason amid high volatility, strained liquidity conditions, and record trading volume in the market. Federal Reserve Chair Jerome Powell, then a Board governor, noted that such episodes, “threaten to erode investor confidence” and that investors need “to have full faith in the structure and functioning of Treasury markets themselves.” The October 15, 2014, “flash rally” led to an interagency staff report on the events of that day, an annual series of Treasury market conferences, additional study of clearing and settlement practices, and the introduction of a new transactions reporting scheme. Many of these developments are discussed in posts (see, for example, here and here) in the Liberty Street Economics archive.

The Flash Rally Episode

On October 15, 2014, the benchmark 10-year Treasury note traded within a 37-basis-point range, only to close just 6 basis points below its opening level. Moreover, in the narrow window between 9:33 a.m. and 9:45 a.m. ET, the 10-year Treasury yield dropped 16 basis points and then rebounded, without a clear cause. Such a large price change and reversal in such a short time, and without an obvious reason, is unprecedented in the recent history of the Treasury market.

The Joint Staff Report

The events of October 15 are described in a report by staff of the U.S. Treasury, the Federal Reserve Board, the New York Fed, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, summarized in this post. While the report does not pinpoint a single cause of the events that day, it does identify notable changes in Treasury market structure. Principal trading firms, for example, were accounting for more than half of traded volume in the electronic interdealer market, a market segment once limited to broker-dealers.

A Series of Treasury Market Conferences

The October 15 episode also led to a continuing series of conferences that provides a forum for examining the evolving Treasury market. These conferences, hosted by the New York Fed and co-sponsored with the other agencies involved in the Joint Staff Report, bring together market participants, policymakers, and academics to discuss the changing market and its drivers. The 2019 conference, for example, featured panel discussions on new developments in debt management, managing risks including liquidity dynamics, and the future of Treasury market structure.

Better Understanding of Clearing and Settlement

The evolving Treasury market has spurred efforts to better understand the extent to which risk management practices have kept pace. To this end, the Treasury Market Practices Group released a consultative white paper, described in this post, on clearing and settlement practices for secondary market trades. The paper describes in detail the many ways Treasury trades are cleared and settled, and identifies potential risk and resiliency issues.

Advent of Treasury TRACE Data

The October 15 flash rally also raised questions about data availability, with the associated report relying on data not typically available to the official sector. Following a deliberative process, described in this post, the Financial Industry Regulatory Authority (FINRA) began requiring the reporting of Treasury transactions by its member broker-dealers as of July 10, 2017, via FINRA’s Trade Reporting and Compliance Engine (TRACE). These data were examined in a post describing trading activity by market segment and in another describing activity by security type and on-the-run/off-the-run status.

For more insight on the Oct. 15, 2014, flash rally and subsequent market developments, see these posts:

Private Eye on the Hedge Funds Supporting Boris Against British Prosperity

Published by Anonymous (not verified) on Fri, 04/10/2019 - 7:09pm in

Yesterday Labour’s John McDonnell wrote to Cabinet Office Secretary Mark Sedwill requesting an inquiry into J. Peasemold BoJob’s connection to hedge funds. His request was based on statements by BoJob’s sister Rachel and the former chancellor, Jeremy Hammond, that Johson was being funded by currency speculators making money on shorting shares. This means effectively betting against the companies they invest in. These companies believe that Brexit will ruin the economy, which means that they, paradoxically, will make immense money from it. Boris’ connection to these financial interests and his determination to bring about Brexit whatever happens are thus highly suspect.

Inquiry demanded into claims Boris Johnson backers will profit from ‘no deal’ – and it can’t come soon enough

It isn’t only McDonnell, Rachel Johnson and Hammond, who are suspicious of the Boorish Generalissimo’s connections to the hedge funds. Private Eye has been discussing this issue in a series of articles since last year, when they first noticed that the hedge funds were heavily backing his campaign for the Tory leadership. Now that Boris is Tory leader, they’ve published several highly critical of his connection to them.

In their edition for 9th-22nd August 2019, the magazine published this article, ‘Shorts Story’ on page 7.

“The people who bet against Britain are going to lose their shirts,” boomed Boris Johnson in his first prime ministerial speech. In fact the betters-against-Britain are the only true winners in Brexit Britain – as the new PM should know.

One big beneficiary is Johnson’s long-time supporter and funder, hedge fund manager Crispin Odey, whose latest gift was a £10,000 cheque for the leadership campaign last month and most of whose funds are domiciled in, er, Ireland, as Eye 1482 pointed out in November.

Odey was public about shorting the pound last year as the process hit Britain’s currency, then earlier this year reversed his position as the market bought into the idea that a no-deal Brexit would be avoided. (Odey’s funds are also profitably shorting major British names including Royal Mail, AA, Debenhams, Autotrader and shopping centre-owning Intu – hardly a vote of confidence in UK plc).

Now that Johnson’s “do or die” Brexit policy and outright rejection of the Irish backstop has sent the pound tumbling again, the short-sellers can cash in once more. As former Goldman Sachs banker and Treasury minister Jim O’Neill told a Radio 4 interviewer last week: “Foreign exchange and hedge fund-type people [are] probably looking at what’s being said coming out of the UK as almost close to a free lunch.” A government that is deliberately promoting the no-Brexit [sic] risk” has left the traders saying “thank goodness for Boris – he’s giving us a chance to make some money”.

In the days before Johnson’s win, and with his coronation looking secure, hedge funds’ bets against the pound rose to more than $6bn worth, according to Reuters. The ensuing fall will have benefited them to the tune of more than $100m. Somebody’s certainly losing their shirt – but it’s not those betting against Britain.

This fortnight’s Private Eye has another piece about the hedge fund’s connections to Boris, and how they are keeping part of their currency trading secret. The article’s titled ‘Crash and Earn’ and it’s on page 7. It runs

Good to see former chancellors and top former Treasury civil servants catching up with the Eye’s concerns over Tory backers profiting from Brexit-induced turmoil. Last year the Eye (issues 1482 & 1485) pointed out how Boris Johnson-funder Crispin Odey was trousering large sums from shorting stocks heavily exposed to the UK economy, and pound itself.

Last month the Byline Times added up the sums bet against UK stocks by hedge funds that had donated to either the prime ministers’s leadership campaign or to Vote Leave. Its finding that there was an “£8bn bet on no-deal crash out” was roundly pooh-poohed – with some justification, given the crudeness of the calculation and the host of other reasons for shorting shares. But that doesn’t mean there aren’t hnefarious motives in the cross-over between short-selling and political influence, as non-conspiracy theorists ex-chancellor Philip Hammond and now ex-Treasury permanent secretary Sir Nicholas Macpherson have observed.

“Mr Hammond is right to question the political connections of some of the hedge funds with a financial interest in no deal,” tweeted Macpherson last weekend. “They are shorting the £ and the country, with the British people the main loser.” Alas, as the Eye put it last year, “there may be rules against rigging the financial markets, but not if the move is big, brazen and political enough.”

Nor is it possible to find out who is placing bets through currency trades, where the political/economic link is most direct. Post-financial crisis, significant share short-sales are publicly disclosed, but currency trades remain secret. Surely time to change this, and for more disclosure of the real financial interests behind those filling Boris Johnson’s boots.

Given the immense profits these people stand to make from the desperate misery and chaos that will follow a no-deal Brexit, it’s perfectly justifiable to call Johnson a traitor, and his backers economic saboteurs. McDonnell is right to call for an inquiry. Legislation needs to be passed forcing currency speculators to disclose their actions, if not a complete overhaul imposed on the financial sector as a whole.

And Johnson needs to be turfed out of parliament, and replaced with Corbyn.

 

How Do Large Banks Manage Their Cash?

Published by Anonymous (not verified) on Wed, 17/07/2019 - 9:00pm in

Jeffrey Levine and Asani Sarkar

Second of two posts

How Do Large Banks Manage Their Cash?

As the aggregate supply of reserves shrinks and large banks implement liquidity regulations, they may follow a variety of liquidity management strategies depending on their business models and the interest rate differences between alternative liquid instruments. For example, the banks may continue to hold large amounts of excess reserves or shift to Treasury or agency securities or shrink their balance sheets. In this post, we provide new evidence on how large banks have managed their cash, which is the largest component of reserves, on a daily basis since the implementation of liquidity regulations.

What Determines a Large Bank’s Cash Holdings?

Banks primarily hold liquid securities to meet ongoing operational funding needs and cover sudden liquidity needs in periods of stress. A bank’s business model determines its services and client relationships and, in turn, its types and amounts of funding. We distinguish between three business models:

  • Universal banks, such as JPMorgan Chase, engage in a diverse range of activities including retail, commercial, and investment banking;
  • Trust banks, such as Bank of New York Mellon, specialize in investment services and asset management for institutional clients; and
  • Legacy broker-dealers, such as Goldman Sachs, originated as investment banks before becoming bank holding companies during the financial crisis of 2008.

The Liquidity Coverage Ratio (LCR ) requires banks to publicly report their prospective net cash outflows in times of stress over a thirty-day calendar period, by balance sheet category. These quarterly reports provide insight into banks’ liquidity management decisions. The chart below reports the average share of gross outflows of the eight largest banks (G-SIBs) from key liability categories (the first bar), from 2017:Q2 (the first quarter when banks were required to report data) to 2018:Q2. The chart also reports the average shares for banks with each of the three business models. We focus on gross outflows to highlight the size of business activities, although the LCR calculation uses the net outflows (that is, gross outflows net of cash inflows).

How Do Large Banks Manage Their Cash?

We discuss below the average gross outflow share of each liability category for all GSIBs and for the business model type with the largest share in that category.

Unsecured wholesale funding, such as unsecured debt and institutional deposits, averaged about 30 percent of total gross outflows across all GSIBs and about 64 percent for the Trust banks. Banks hold cash against these liabilities because institutional deposits can be withdrawn quickly and maturing debt has to be replaced or renewed. Trust banks also hold operational deposits acquired in the process of providing financial services, such as clearing and settlement of securities, to their institutional clients.

Secured wholesale funding, such as repurchase agreements or “repos” and securities lendings, comprised about 23 percent of total gross outflows for GSIBs and 40 percent for broker-dealers. Broker-dealers are heavy users of secured funding as they are securities market makers and also assist clients in funding trading positions. Notably, the public LCR data show that broker-dealers report large cash inflows from secured funding—for example, by lending cash through reverse repos—as part of their net cash outflow calculations.

Retail deposits, such as brokered and transactions deposits and certificates of deposits, were 19 percent of gross outflows for GSIBs and 30 percent for Universal banks, which tend to have large retail banking operations that fund much of their liabilities. Although retail deposits are insured by the FDIC and historically have remained stable even in crisis, banks hold a buffer against them because they can be withdrawn on demand.

Derivatives and commitments were 18 percent of gross outflows for GSIBs and 20 percent for Universal banks. A bank may act as market maker for its derivatives clients or it may use derivatives to manage its own risk. Commitments include credit and liquidity facilities that provide committed lines of credit to customers. Cash is needed, for example, to meet margin calls on derivatives positions or drawdowns of lines of credit.

Contingent funding was 10 percent of gross outflows for GSIBs and 23 percent for broker-dealers. These are bank commitments related to acquisitions or lendings that are contingent in nature, since customers often use them for short periods before replacing them with other financing sources.

Daily Cash Management Strategies of Large Banks

The public reports provide snapshots as of the end of each quarter. To provide insight into banks’ daily cash management strategies, we use daily data from regulatory reports from 2016 to 2017 on liquid assets of the commercial banking subsidiaries of GSIBs. The cash balances of GSIBs are fairly stable but with some daily variation.

To capture the cash dynamics, we use a statistical model to estimate a bank’s desired level of daily cash holdings, as a function of several factors. These factors include the anticipated amount of high quality liquid assets or HQLA that banks hold to abide by liquidity regulations and internal liquidity stress tests. The estimated level also depends on the composition of their gross “stress” outflows (that is, the expected outflows in a stress situation), as previously discussed. Finally, the opportunity cost of holding alternative liquid assets (for example, the interest rate on Treasuries or repo relative to excess reserves) also matters.

A bank’s actual and estimated desired daily cash holdings will vary due to funding shocks and other unanticipated changes in balance sheet items. We assume that, when this happens, banks plan to gradually move back to implicit desired levels. Our statistical model enables us to simultaneously estimate both the desired level and how quickly banks move back to it when hit by funding shocks.

Do banks manage cash as if they have a long-run desired level that they adjust to?

The chart below indicates that the largest banks appear to manage their actual cash levels (gold line) close to the desired level (blue line). How strictly an individual bank manages cash to its desired level depends on its business model. For example, for banks with more capital markets activities, cash levels are more susceptible to market price movements and daily cash balances are more likely to veer from the desired level. On average, however, their cash balances appear quite stable. When daily cash balances deviate from their desired levels (red line), banks gradually return to their desired levels over a period of six to seven days.

How Do Large Banks Manage Their Cash?

Evolution of the Demand for Reserves by Large Banks

To what extent can different liquid assets be substituted? We find that desired cash balances vary inversely with a bank’s holdings of U.S. Treasury securities, which suggests that banks are willing to substitute cash with Treasuries to some extent. A few banks also substitute agency securities for cash. On the liabilities side, we find that banks hold cash buffers against stress outflows from certain secured and unsecured funding categories. Overall, these results suggest that large banks are likely to change their mix of liquid assets and liabilities holistically in response to shrinking reserves, rather than simply adjusting excess reserves and Treasuries.

Large banks’ cash management strategies are heterogeneous and shift over time, indicating that changes in reserves demand are likely to be bank- and period-specific. For example, some banks substitute cash and Treasury balances one-for-one while others are less inclined to replace reserves with Treasury securities. Similarly, on the liabilities side, the desired cash levels of universal banks are strongly correlated with their anticipated retail deposit outflows, while institutional deposit outflows are more important for other banks. Finally, banks appear to have held larger cash balances in 2017 than 2016, even after accounting for changes in their balance sheets.

Interest Rates and Cash Balances

Lastly, large banks are sensitive to the opportunity cost of holding cash. For example, when Treasury bill rates increase relative to the Interest Rate on Excess Reserves (IOER), banks reduce the amount of cash they hold, all else equal. A few banks also hold less cash when the difference between repo rates and the IOER widens, making cash less attractive relative to secured assets.

The chart below plots indexes of the Treasury-IOER and repo-IOER spreads. Since 2017, these spreads--and the Treasury spread, in particular—have started to widen from a low base. This widening provides incentives for banks to substitute cash for other liquid, cash-like assets (and Treasuries, in particular). As rates rise, the cost of bank liabilities also increases and banks have a greater incentive to reallocate cash holdings into higher yielding liquid assets.

How Do Large Banks Manage Their Cash?

Summing Up

Why do large U.S. banks hold considerable amounts of low-yielding cash, other than to meet liquidity requirements? Our analysis shows that large banks have a long-run desired cash level and they manage their actual cash balances closely to their desired amounts. However, this desired amount varies over time with the composition of each bank’s balance sheet (which in turn is strongly influenced by its business model, more generally), and the opportunity cost of holding cash relative to earning assets.

Jeffrey Levine
Jeffrey Levine is a policy and market analysis senior associate in the Federal Reserve Bank of New York’s Markets Group.

Asani Sarkar
Asani Sarkar is an assistant vice president in the Bank’s Research and Statistics Group


How to cite this post:


Jeffrey Levine and Asani Sarkar, “How Do Large Bank Manage Their Cash?,” Federal Reserve Bank of New York Liberty Street Economics, July 17, 2019, https://libertystreeteconomics.newyorkfed.org/2019/07/how-do-large-banks....




Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.