Why Are Repo Rates Spiking?

Okay, very good morning. I hope everyone is doing well. The day has arrived, it is the FOMC decision day. So it's Wednesday the 18th of September. Just as a heads up straight off the bat, Sam and I will be covering, and the rest of the team here in London, the full FOMC decision live via our YouTube channel. So if you don't already do so, all you need to do is subscribe to the channel and click the bell icon, which will turn on your notifications and you'll get an immediate push on your phone and you can join us live. So via your mobile, you'll be able to ask questions, listen into the session. We're going to kick things off from 6:30 PM London time. That gives us half an hour to do a bit of a preview for what it is that we're expecting from my side fundamentally, uh, and then from Sam in a technical setup sense from a trading point of view. We'll then listen to the release and then we'll do a bit of a, a debrief. We've also got the press conference and everything else, so hopefully you can join us for that session. So that does mean for my briefing this morning I'm going to keep the Fed conversation relatively short because I'm going to go into that in much greater detail later on this evening, uh, when we cover it live. So first things first, let's just have a quick look at the, the overall kind of sentiment for the market open. And as you would expect ahead of that central bank decision, things are relatively quiet. The dollar index up a touch, 0.1%. Cable and EURUSD trading just minor negative territory. Cable at the moment just having a little look at its daily pivot level in the futures. Gold down about $4, but again, some support seen at the overnight Asia-Pacific low, but equally around its pivot level as well. The 10-year up about 4 ticks with just slightly negative global stock futures seen this morning and overnight. So as normally the case ahead of those big news-driven events coming out of particularly the Federal Reserve, it's almost like a wait and see now for how that plays out. Oil, of course, highly volatile over the last couple of days. We had that huge record gap up and then big— biggest intraday move that we've seen ever. And then we had to pull back to the technical relevant levels to then surge back higher after it was a bit questionable about how quickly they could get production back online at some of their key facilities in Saudi Arabia. The news broke yesterday, and let me just refresh your memories of what exactly that was. that was this— that Saudi Arabia had partially restored output at the damaged oil plant, crude flow back to said to be at 2 million barrels per day. Remember, the impact overall at the beginning was understood to be about 5.7 million barrels per day. So that, even though they're saying that production capacity may not be fully restored until November, catching the market a little off guard given how quickly They are looking to kind of mitigate that circumstance that occurred at the— or the situation that occurred at the weekend. So that immediately caused some selling pressure, but again, finding, although a bit messy, some support around the same type of level that we did on the initial pullback on the beginning of the week. What I would say is that, you know, are we going to get a gap fill eventually? Well, I do kind of think that this kind of area personally Uh, let me just change my transition, my charts here. So again, this was the ebb and flow of the price movement, uh, and, and yesterday finding some support roughly around that same area as we did on Monday morning. But yeah, are we going to get a gap fill down here? I, I don't think so personally. I think that, you know, just given— even though yes, Saudi Arabia seemingly, it seems they can, they can get back on their feet quite quickly, I would say that geopolitical risk that has now picked up a notch or two on the back of now where do we go from here. And obviously the tensions with Iran are not going anywhere anytime soon. I do think that this kind of 58 kind of level here, perhaps a decent fair value for the moment with the fundamentals that are in play. And so I continue to see this as quite a good strong area of support. If broken, sure, potentially then on the same factor, uh, could get a decent run lower. But for the moment, I think that's going to be a pretty, uh, good area where we might start to see a bit of consolidation around between 58 and 60 essentially. So with that in mind, the pivot of 59.76 today in the futures, um, from a trading point of view, from the Saudi situation, I would say that, um, the kind of dramatic moves now Now that we've had that news from yesterday about the latest kind of tentative timelines about how quickly and to what amount they're going to get production back online, I would say the kind of firepower of the ability of the headline news out of that situation or region to impact the price may be dissipating a touch on the Saudi stuff. Not unless there is obviously a new attack of some sort and then things could flare up, of course, particularly quickly. Um, just going straight into the news then. Let's have a just a quick overview, as I said, on the Federal Reserve. I'll go into this in much greater detail later this evening, but a divided Fed may be reluctant to forecast more cuts. This is what Bloomberg are reporting this morning. The FOMC expected to lower rates, but dots may send— excuse me— a hawkish signal. Oil price spike reinforces the sense geopolitical risks are rising. So The reason why they're talking about this division is that, uh, that was apparent in the last meeting when the Fed chose to cut rates for the first time in this kind of mid-cycle adjustment. And it's believed to be that we're going to see some dissenters today, uh, Esther George and Eric Rosengren, the more outlying hawks, arguing that we do not need to cut at all at this point. We shouldn't have cut in the first place. Then you've got the likes of Bullard, who typically sits right on the other end of the spectrum, saying that, look, never mind 25, how about 50 basis points? So there definitely is a sense of division. And of course, this does come at a time where there's arguments really for both sides. If you think about things like nonfarm payrolls, perhaps a little bit softer, has been deteriorating, albeit still holding up at relatively high levels. You've now got this geopolitical renewed risk perhaps in the Persian Gulf. You've got the ongoing trade war risk, of course, as well, the kind of the uncertainties around that. However, on the balance, US economic data has definitely been improving in terms of when looking at all data sets. And so there's definitely argument to suggest that perhaps, perhaps we don't even need to cut today. At all. What do the markets think? Well, check this out. This has been one of the most, uh, rapidly changing graphics I've seen for a Fed decision in quite a while. And if you think about it, rewind the clock about 3 weeks or so, possibly 4, and it wasn't a case of holding rates, it was a case of 25 or 50. You remember when everyone was talking about the inversion of the yield curve? And it felt like the media were trying to tell us that the end is nigh and so on. Well, that's disappeared. The inversion of the yield curve no longer is apparent. That has pared back a lot of that move in step with what I've said was improving economic data situation that we've seen in the States. So now forget 50. No one in the market is anticipating 50. And in fact, today has almost become a toss-up between— it's almost a 50/50 bet, hold or cut 25. So I am way more excited about tonight now than I was a few weeks ago, because when you see a 56.5 to 43.5% probability, so still tilted slightly to a cut, either way they go, the market's going to move sharply on that initial announcement. Depending on what option they take. But of course, we know with the Federal Reserve, this isn't just about this hike, it's about the subsequent hikes thereafter. So this is looking at where federal funds rate futures implied probabilities put rates at the end of the year. And as you can see here, there's about a 16% probability that markets are expecting rates might remain where they are exactly today. So never mind no cut today, no cut for the rest of the of the year. Obviously, the further out down the timeline you go, the more risk there are to the accuracy of these numbers, because obviously between now and the end of the year there's lots of things that could occur to, to change the situation. But the way markets are priced today, which is important for ascertaining the reaction function of how assets will move at the initial announcement tonight, it's actually 41.5% most likely that rates will just be one cut lower than where they are today, a range of 1.75 to 2 So yeah, quite interesting to see how this has shifted. And of course, we get the summary of economic projections later, and then we get the press conference as well. So as I said, we'll cover that in full, but it's going to be particularly interesting. Markets right on the fence about what exactly that, uh, the initial rate decision is going to be this evening. The other thing, of course, you might have heard about a lot of people been talking about this chart. If it, if it looks frightening, that's probably because it is frightening. It's the US overnight repo rate, and it surged beginning of the week. It kind of back to back did it again yesterday. Typically the repo rate is something which kind of trickles along, as you can see here over the last 2 months, at around the federal funds rate, which which is let's say 2%, but it's more than 5 times higher than that as of yesterday, hit 10%. Now I did send out to you guys this morning and explain our article about what is a repo rate because I've had quite a few questions yesterday. Not a lot of people who are new to markets are too familiar with this process, but it is an absolutely pivotal and essential operational kind of option or, or part of how markets function, uh, day to day. And so what I thought I'd do, I'd quickly run through a couple of headlines of what exactly this is, just so we're all on point, because the Federal Reserve are going to be looking to add more liquidity to the system later today. So when you see those headlines, you're just a little bit more informed about what is going on. So The repo rate talks about essentially cash available for banks for their short-term funding. And as you can see then, as kind of like with the LIBOR rate, if you remember back to the financial crisis, or the interbank lending rate, once these rates start to spike higher, it means then that it has an inability for lenders to lend to one another because you get this kind of credit crunch, if you like. And so we've had this big surge, which means liquidity dries up. Now that's a big problem because banks need liquidity in order to meet their daily operational needs and maintain sufficient reserves, just day to day. So what happens as a process is that Wall Street banks, they offer US Treasuries and other high-quality securities to raise cash, more often than not overnight, to finance their trading and lending activities because Remember, financial institutions are not just trading markets. That's only one very small part of what they do. The other big part is lending activities to a variety of different market participants, including other banks, of course. What happens then is the next day— so after they've, they basically offered these, these assets or collateral to raise cash overnight— the next day, borrowers repay their loans plus what it typically is, a nominal rate of interest to get their bonds back. So a nominal rate normally would be 2% in line with the federal funds rate, but if it was 10%, well then wow, there's no way that you would offer to lend that money knowing that you've got to pay back then a 10% premium on it, which is 5 times more than your regular amount. So what happens is this is a massive risk to markets in terms of the day-to-day operational functions of the banking system. And so it forces the Fed to intervene, to add emergency liquidity in an injection that they did yesterday of $50 billion. Now, is this the first time that the Fed have had to do this? Absolutely not. They were very active. I remember doing this during the, uh, right in the middle of the severity of the global financial crisis, back when Lehman collapsed. As you can imagine, banks were woefully short of liquidity. No other institution wanted to lend to another counterparty, so the Fed had to add liquidity day after day after day. If you bring this into our own, although slightly different, um, system, this is when RBS had, what, a £100 billion shortfall in meeting its overnight obligations, which is when then, uh, obviously the government had to step in the central bank adding short-term liquidity and the government taking ownership of the bank at that point. So yeah, this, um, is it shocking news? Is it going to move all different assets? No. Is it a factor that could well be brought up in the Q&A with the Federal Reserve Chair Jerome Powell today? Yes. Is it something to monitor going forward? Yes. So it definitely could, if it becomes becomes a continuous thing that, that gets seen every day, that means it's another thing that the Fed are going to have to throw some monetary power at. And obviously it does require large amounts of funding, so they're looking to conduct another one today, and reportedly that's going to be another $75 billion. Now the question might well come, why is this happening? Well, there's 3 main reasons that people, from what I've read, are pinning this on from this morning, but it is somewhat debatable. Number 1 is corporations had to withdraw funds from money market accounts to pay quarterly tax bills. So if you think about the actual participants within what makes this repo market function, their, their liquidity is drawn down because of the fact that they've had to make a, a seasonal quarterly tax bill payment. That also coming on the same days when last week we had $78 billion Treasury kind of funding round from the US Treasury. Uh, that means then that all of those banks and investors who bought into those bonds that were sold by the US government last week now have to settle up. So again, withdrawing more liquidity from the system as they make those payments. And then finally, reserves that banks park with the Fed are often made available to other banks on an overnight basis are at their lowest level since 2011. So again, the amount of reserves generally that banks have available to them to lend to other institutions is the lowest it's been in about 8 years. This has come as the Fed have tried to cull a lot of its vast portfolio of bonds that they've accumulated over the last few years through the three phases of quantitative easing post-financial crisis. So all of those three things all equate to withdrawal of liquidity, but importantly, they've all come right at the same time. The latter point probably has been ongoing, but the Treasury funding round from last week, in addition to the quarterly tax bill payments for corporations, has led to this funding squeeze and consequently this repo rate surge. Do I actually think this will become a bigger thing? No. But what it does actually entail though is probably in time some tweaking of monetary policy when we start looking at the more complicated details outside of just normal interest rates and dot plots and so on, that they're going to have to change because, uh, that this, this funding situation is fairly pressured at the moment and will probably likely to continue to do so for some period of time. So some changes do need to be made technically to how they operate. Okay, hopefully that makes sense and that's a bit more clearer on what exactly that is. Final thing, just to finish off on my side, I did read this this morning. Looming election, in reference to the UK, is set to delay the appointment of Bank of England governor So Mark Carney could be asked to extend his tenure again. I think this would be the third time. Uh, there are other articles on the FT talking about who could be his replacement— Andrew Bailey or Ben Broadbent or lots of others as well. Um, but the point being is that obviously we're coming to this pivotal point of where Brexit could well be delayed again. To the end of January of 2020. And so I guess what really would be, would be the most prudent thing to do from a planning point of view is have some degree of continuity. So if Carney were to stay, I think that would be the best course of action from a Bank of England's job of market stability point of view. But if they were to change, then all the more reason why I think they should say select someone more organically, perhaps someone like Ben Broadbent, because he's been part of the top-level decision-making through the process, and he'll know the kind of tact and guidance that very closely that Carney has been deploying. Okay, calendar-wise today, and then I'll hand you over to Sam, what have we got? So UK CPI data is coming out later this morning, um, Could that be market moving? Well, sure it could be, but, um, only would I would say if it was way out of the, um, consensus estimates. We got a range of 1.6 to 2.2 at the high. The expectation year-on-year is 1.9%. So, um, I would watch that. I certainly would say stay clear of having any position on while the data comes out. But yeah, it would need to be down at the 1.5% kind of reading or up at the 2.4%, I think, really to see a decent move in markets, just because everyone's sidetracked by political ongoings UK-wise and the Fed decision looming dollar-wise. CPI comes, of course, alongside RPI and PPI, uh, so all at 9:30. You then get Eurozone final CPI. So again, final reading is likely to not move the market then for that reason. This afternoon, US building permits, housing starts for August, Canadian inflation data, weekly oil inventories. So I will post those API numbers into the chat room. I'll get Sam to cover those in a second. And then you've got the FOMC decision of course happening later on with Fed Chair Powell to back that up press conference at 7:30. But again, we'll recover that. 6:30 we go live on YouTube, so hopefully you can join us. Uh, there will be a chat function, ability to ask questions as well. So happy to help, um, kind of guide you through that volatility when the release comes out. Good stuff. All right, hand you over to Sam, and I wish you a good day ahead until that time. Thanks very much.

Yeah, hi guys, hope we're, we're all doing well and ready for this evening. So we'll come on the mic closer to the time, uh, and then on YouTube as well. We'll go through some of the levels of, of how we're trading going into, uh, the event. Before we get on to the main dollar-related markets, we'll have a quick look over at oil, which you can see a couple of times really you know, had a, had a go at trying to break through the, uh, the low that we, we've had and we reached on, on Monday morning. Obviously that being the, the high that we had back on the 10th— was it the 10th? 31st, sorry. Uh, yeah, and then it was the 10th, wasn't it? Yeah. Uh, that held well, and since then we've had another go at trying to break through some of these levels and just can't get, get, uh, get down there for that gap fill, you know. Obviously looking at this more technically as well. I think that's going to remain to be a trade opportunity if we were to potentially get the— maybe the DOE's overly bearish, you know, could get through there if you have some big dollar strength as well that could come through later on. And, and obviously it's a big, big, uh, push down to where we finished Friday around 54.85 on the futures. Last night's, uh, DOE numbers coming in, or the headline, which was expected to be a draw of -2.5, coming in at a build of just over 500,592. Uh, Cushing was a draw of -846, gasoline a build of 1.6 mil, and distillate build as well. If we have a look at the, uh, that— so I have to zoom in here, and it's a standard sort of API-sized candle you can see here. So relatively small, relatively contained, slightly mixed on the— on that reading there. Of course, bigger things going on at the moment. Just the way oil is looking, obviously talking about that gap fill, if you like, but also you can see just from this morning we're starting to, to get that trend to the upside. And oil, like gold, is one of those markets that when you do get a strong trend developing in the morning it offers a good opportunity for that breakthrough, uh, to the downside as well. Looking, uh, at some of the levels from, from yesterday and around the pivot and sort of $60, you got, uh, yesterday evening's, uh, some resistance on the pivot, which looks quite good. And, uh, not that we're going to get up to that R1, but you can remember yesterday we were talking just about, uh, the, the neckline, if you like, from the— what was the, the double top Obviously we've moved contracts here, so it looks slightly different now. But that break of that, of course, coupled in with the, the Saudi headlines, saw a decent push to the downside. So a couple interesting levels to have marked up there for oil. Currency-wise, let's have a quick look just where we're trading. If I put this on a 240 chart, you can see the euro here. Again, it's a market that just couldn't— like the pound— break that low and we couldn't then again to the upside get above some resistance that we had back on the 29th. So, so we're sort of stuck within this range, uh, from 1.1011 to 1.1180, which, you know, ahead of a central bank meeting of this significance isn't all too surprising, uh, to be honest. You can see over the last— if I just put this on back to a 60— you can see over the last sort of couple of sessions we're just getting— starting to again develop different trend lines from these highs. And you can see relatively well respected to, to that side there. So looking maybe break of there, yesterday's highs, and then you're looking at the, the highs of the week. Uh, to the downside, you've got some interesting levels just below, I would say, the, the pivot where we've had decent price action around 111.14. So as a line in the sand for the morning, it's not too bad. But really, I would be more focusing on and just holding off and waiting for, for really this, this evening, uh, so in the build-up, uh, 6:30 to 7 o'clock, uh, when the headline comes out, and then obviously the press conference 30 minutes later, would really just be, you know, prepping for then, uh, if you like. Other key levels to be aware of just to the downside, again, just below that S1, previous high of yesterday. And I also do quite like the look of what was yesterday's low and also the low of the 11th. I think that's a pretty key area to have on as well. Pound, obviously with the Fed later, um, you know, the pound is going to move but probably not to the extent that euro-dollar is. It's still going to be Brexit the main driver here, focus, rightly so, should be elsewhere. And, and yesterday's low, we, we got a test just after the briefing really of the level we were talking about, and that, that was the close high from the 9th, uh, and all the other highs as well. And the retest of that trend line obviously was something that would probably be, uh, you know, to be discussed at a later event, that coming in at S1 today. But for now, good support held up there. And now you could also argue that if we were to get any further push below this pivot in 125, taking into account the highs that we had from overnight yesterday and yesterday morning, which comes in just above the S1. So some nice support just below. We're trading the failure really to, to break above the high that we had on the 13th, on Friday, uh, has seen us drift lower. And if we put this onto the 15-minute, you can see as well, just perhaps at some point we're going to start to make this other trend here as well to keep a watch on. As with any break lower in the morning, you can see here, worth having on that trend line as well. That's where the move just, uh, on the open, uh, really pushed lower. So a retest of that is of course something to have marked up. So rather than maybe attacking the pivot, even though technically it's not too bad, I prefer to look to get short a bit higher up on that. S&P really— I mean, yesterday was pretty quiet on the S&P. The range from the, the high to the low, pretty small, 95 3 to 0.9, so 16 points. Um, you know, maybe we would have loved that back in 2017, but we've sort of got used to the S&P actually really moving now. Uh, that gap fill has really taken place though, of course. And, uh, from overnight on the weekend, uh, we couldn't really, you know, push lower at all. And you can see again this trend line worth having on from the low that we had back on Monday as well, just to really get everything squeezed in. If we can get a confirmed break above 0.09, then, you know, why can't we get the highest from last week where we obviously got very big resistance level? Um, you know, I've seen some tweets yesterday that people are, are reckoning we're going all-time highs today, just the way we're sort of priced in and the unwind of this rate cut. And you can see, if you have a look at this, that longer-term chart with the all-time high in the mix, you see how close we are percent-wise. Roughly do this as 0.9, so I could easily do that in a day, couldn't it? The same levels, uh, as usual to the downside, obviously the, the 46 to have up, and then this trend line that we're starting to get starting from the 10th of September. But as mentioned, we'll go through all of these in more detail ahead of the time as this morning I would prioritize more a case of just sort of prepping and planning, uh, for, for the session, uh, ahead. Obviously got the UK data out at 9 as well, but main focus is going to be elsewhere. Gold as well, you can see quite choppy, uh, quite range-bound. That obviously the lows that we can call it, 1494, very key. But also here, I was looking yesterday with the, the new guys in, in in Stage 1 of the, the career program and just talking about the significance of this whole area. You can call it 89 to the 93, 94 point. There's such good support, you know, a break of that later and, you know, no rate cut and potentially a bit more hawkish on the press conference and projections could really see us push down. And I, I think we could have quite a quick move down to sort of 68 and, and 60 So certainly a key zone that I would have marked up. On the flip side, you know, if they were to go more down the dovish route, you know, a key resistance level to the upside at 1525. I don't think it's out of the question that 89 or 25 gets tested today. I think it could be a really good meeting. So please, you know, do join us later on. Just having a quick look over the Bund. You can see pushing up this morning. So worth having this trend line drawn on from the last couple of days. That's probably not far off, you know, getting tested with, uh, sort of the lows that we had back on Friday and obviously the high of yesterday as well. T-notes following suit, up to its high after we said it was the worst week since November 2016. We have just been drifting. Probably worth even seeing if there's a bit of a trend channel on this at some point. If we were to make another low. So bonds just pushing to, to the upside there. Any questions, as usual, please do let us know. I hope you have a good day, and feel free to join us later on in, in what should be a pretty good meeting.