Being An Economist Means Never Having To Say Deflation

In January 2017, there was a lot of praise for Goldman Sachs, especially in London. This stood in obvious contrast to another global peer being savaged. While Deutsche Bank couldn’t pull its name out of the sewer, GS’s London unit was heralded for standing up when the market needed it.

Brexit was a fascinating story in ways that had absolutely nothing to do with the politics. You look at any market chart and you can easily pick out when the vote happened. It was as much about pounds and LIBOR as it was the European Union.

Uncertainty is a liquidity killer. There is both a common sense reason as well as purely mathematical. If as a dealer you don’t know what you don’t know, you can’t deal. In terms of how balance sheets are actually put together, uncertainty is something like vol approaching infinity. Sheer paralysis; every position far too expansive and expensive to consider.

This is especially vindictive in the context of global funding; dealers depend on each other (incestuous) to lay off the risks of conducting regular functions. That’s what made 2008 (and the other Euro$ squeezes) so pernicious; the tendency of one bank to pull back immediately weakens the whole system. Redundancies, or what are thought to be redundancies, become bottlenecks.

It takes a whole lot to stand in front of uncertainty and fill the void (or what central banks are supposed to do, but can’t). In the two weeks before the Brexit referendum in late June 2016, the close election indicated a wildly unpredictable outcome. Liquidity started to become scarce.

For money dealers, if you do provide funding where do you lay off risk? Or do you take on risk yourself?

The cross-market nature of our product set allows us to offer better liquidity to clients than if we were simply showing a price and trying to find the exact offset in the market. If we see greater depth in the forwards market than the rates market, we may choose to hedge a client forward trade with a rates trade. Warehousing this basis risk between the two markets allows us to offer the best liquidity to clients and minimise our execution footprint.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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