G-SIBs And Jay Powell

At year-end 2018, G-SIBs rationally performed the shrinkage but shocked financial markets in doing so. Most investors don’t delve deeply into this arena and were therefore scared by the December market selloff and its aftermath.

This is just one of many examples of a liquidity crunch scare and market gyrations induced by rules and regulations rather than by traditional market forces.

At yearend the repo rate for an overnight transaction spiked. At one point it was 5% instead of about 2%. There were a few days of the run-up to the spike and a few more as it unwound. The stock market waterfall coincided with this period, as panicked investors fled the markets for emotional reasons, fearing a liquidity crunch.

At the end of December, the credit spread between HYG and GT10 was 314 basis points. On the September 2018 close, it had been 234. It narrowed in January.

As 2018 drew to a close, Moody’s Baa Corp versus GT10 was 245, as opposed to 183 at the end of September. It is lower today.

While T-bills and other similar riskless rates didn’t change much during the year-end period, other riskless rate measures changed dramatically. That is how we could narrow the culprit to a rule and not a liquidity event.

SOFR, the secured overnight financing rate, is a developing benchmark. It was 300 basis points at yearend. It was 216 at the end of September and is about 240 today. Twenty-five bps of the difference between September and today is attributable to a quarter-point hike by the Fed. The other 60 bps is due to the rule change, that is, to the bank shrinkage effect.

From this metric, we can estimate the cost of this rule. Here goes.

A single basis point cost on $1 trillion is $100 million annually. Divide that by the number of days in a year, and the daily cost for every trillion dollars is $280,000. At yearend, for one day of the SOFR distortion, we multiply by 60 bps to get about $17 million cost for a single day for American banks. Remember, there were also days running up to the peak, followed by days running off the peak, as G-SIBs unwound their shrinkage trades.

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Disclaimer: The preceding was provided by Cumberland Advisors, Home Office: One Sarasota Tower, 2 N. Tamiami Trail, Suite 303, Sarasota, FL 34236; New Jersey Office: 614 Landis Ave, Vineland, NJ ...

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