The views and opinions expressed in this article are those of the thought leader and not those of CeFPro.
By Oskar Rogg, Head of Treasury, Credit Agricole
How have liquidity and repo markets evolved over the last twelve months?
The last 12 months have been rather eventful in the short term space. We saw the repo market dislocation last September 2019, where rates spiked upwards dramatically, despite no change in rate or credit outlook.
Six months later, we saw the COVID-related events of March 2020. Most of the financial markets migrated from dealing rooms to spare bedrooms. Central banks intervened aggressively to ensure that the economic crisis surrounding COVID wasn’t exacerbated by a liquidity crunch. Stakeholders, from corporate borrowers to institutional investors to financial intermediaries, responded to the human and financial markets implications of, and unknowns surrounding, the pandemic.
We saw Fed balance sheet normalization go forward at low speed and backward at high speed. We saw the official sector dust off acronyms from 2008 and supplement them with even more broadly focused 13(3) facilities.
In a sense, there had been a lot of changes to the financial markets in the decade since 2008, regulatory and otherwise… events in the last 12 months constituted the kind of vigorous shaking that inevitably provides insights as to how the various pieces fit together.
What trends have we seen in short term rates and flows across the secured and unsecured markets?
There is no question that the events of last September spooked the market, particularly since there were no obvious fundamentals driving the disruption. After the Fed stepped in with a backstop, it took some time to reassure market participants that the official sector was committed to ensuring stable markets. I think the markets have developed a more nuanced understanding of the transmission mechanisms between the unsecured and secured funding markets, particularly related to timing considerations and regulatory constraints.
In March, the market was concerned about liquidity as COVID unfolded, and this concern showed up in rates and flows. The Fed unleashed a massive and relentless show of firepower to again reinforce its commitment to stable markets that would trade in a range consistent with the central bank’s monetary policy goals. Since then, we have seen some tweaks designed to redefine its role from active participant to backstop, and markets have become more comfortable with new realities.
How have treasury and funding been affected by recent developments?
The watchwords for treasury and funding have always been visibility and resiliency. The events of 2020 reinforced the importance of both. If your balance sheet, liquidity sources, regulatory framework or the market in general is changing, you want to be on top of those changes – you need crystal clear, timely visibility so you can adjust your calculus accordingly. At the same time, you want to build resiliency into your operating model such that changes or uncertainties in the market don’t have an undue impact on your business or on your economics.
What do you see ahead for short term markets and how can industry professionals best prepare?
Current fiscal policies imply substantial government debt issuance on an ongoing basis, which implies substantial ongoing financing needs in the secured markets. The central banks have made it clear that short term rates will remain low; that they will inject liquidity as needed; and that they will take a highly proactive approach to ensuring markets remain stable, liquid and supportive of an eventual economic recovery. It’s not just the official sector – let’s face it – the longest peacetime expansion in modern history came to a screeching halt for a totally unexpected reason. The financial system as a whole is rethinking some of the traditional risk reward trade-offs.
So the base case is low rates, ample liquidity, and low volatility that may persist for some time. That said, just because the surface appears placid doesn’t mean the underlying stresses and fissures have disappeared. As we have learned with QE and normalization, the path out is seldom a mirror image of the path in. Relentlessly seeking to understand those underlying dynamics (even if their impacts are temporarily muted) is critical for industry professionals. Understanding the implications of the LIBOR to SOFR transition will also be important.
The past year has provided a lot of data and forced everyone to revisit many of their assumptions. The coming years will likely be similarly educational.