E The Derivatives Monster Creates A Bull From Capital, Not Labor

In my previous article on repo, I talked about Wolf Richter's view that a snapback could have made treasury bonds temporarily undesirable. Also, Chairman Powell was quoted where he uttered these soothing words:

...overall financial stability vulnerabilities are moderate.

This Fed doubletalk was meant to soothe. There is only a moderate, not minor, risk of vulnerabilities to financial stability! Not so soothing, if you rephrase it.

It appears that treasuries for use as collateral are only trustworthy if yields stabilize or decline. Counterparties are deathly afraid of yields snapping back up! They would prefer yields to relentlessly decline so the value of their collateral would make margin calls infrequent. So, what are the implications as we approach the zero lower bound and negative rates?

Japan, on the heels of treasury weakness, also had a weak 10 year auction because the government seems weary of propping up the bond markets. And yet it appears that the Fed is just beginning to prop up our bond markets.

So what could have happened causing the snap back?

1. Lack of cash. This is given as the standard reason for the sudden rise in rates. Taxes had to be paid. Accounts had to be settled. But maybe if we read on we can see the lack of cash is more endemic?

2. Too many treasury bonds. This has been put forward as a reason in various articles recently. Derivatives generally create massive demand for treasury bonds, with a relentless downward yield, yet sometimes that demand is weakened. Taper tantrums come to mind.

3. Market manipulation by primary dealers. This is always a possibility since the banks have customers who want yield. We know that some folks believe that treasury auctions have been rigged in the past. Now we find out that banks, with JP Morgan in the lead, have been taking cash out of the money markets. This appears to be an abuse of the counterparties. But you would have to ask a banker. Maybe they deserve it. 

4. Fear of lurking bad collateral like CLOs and collateral put up over the counter with no clearinghouse scrutiny. Fear that almost half of derivatives deals are not through clearinghouses. Fear that derivatives just aren't safe.

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Disclosure: I have no financial interest in any companies or industries mentioned. I am not an investment counselor nor am I an attorney so my views are not to be considered investment ...

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