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All You Want To Know About The SLR, And What The Fed Needs To Do About It During The FOMC Meeting On March 17

Mar. 17, 2021 7:12 AM ET4 Comments
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  • Tools suggests there seems to be much larger upside potential for NDX, which implies that the primary mover for the next equity rally may be a fall in bond yields.
  • Fed inaction on SLR issue may cause yields to surge further. Analysts say that if the 10Yr yield goes as high as 2.00%, Nasdaq will shed 20% of its valuation.
  • It is unlikely that the Fed will ignore the bond yield surge hullabaloo, when there are very simple solutions to the bond tantrum of the Primary Dealers and Investment Banks.
  • On aggregate basis, US banks may dump as much as $650 billion of US Treasury securities in very short order, if the SLR is re-imposed with no relief to PDs/MOTUs.
  • In reality, the MOTUs are not asking for a REPEAL of that buffer provision -- but to make the temporary adjustment to the calculation of the supplementary leverage ratio (SLR), which lowered capital requirements for top US banks, be made permanent. If the SLR is reimposed by April 1 with no change, you have the MOTUs shedding US Treasuries, except for bond holding necessary to transact their business as Primary Dealers.

MARCH 16, 2021

RM13Mar 16, 2021 1:19 AM

In the past year, market has rejected VIX less than 20. If it stays there past Wednesday, it's a pivot into lower VIX.

'According to analyst Dan Dolev, nearly two-in-five of the recipients surveyed expect to use some portion of the money to invest, and in a novel if unsurprising twist, check recipients said they prefer Bitcoin to stocks: “Bitcoin is the preferred investment choice among check recipients. It comprises nearly 60% of the incremental spend, which may imply $25 billion of incremental spend on Bitcoin from stimulus checks,” said the Mizuho analyst. “This represents 2-3% of Bitcoin’s current $1.1 trillion market cap.”'

From 100 Million Stimmys To Be Delivered In Next 10 Days: How Much Will Go Into Bitcoin

Around 10% of U.S. stimulus checks may be used to buy Bitcoin and stocks, equating to around $40BN in total.

h.voiceMar 16, 2021 8:11 AM

Continuing the VIX conversation I have these two (slightly dated) studies saved about stock-bond correlations. http://public.kenan-flagler.unc.edu/faculty/connolly/StivSunConn_JFQA.pdf

(PDF) Why Does the Correlation Between Stock and Bond Returns Vary Over Time?

This was one of parts I had highlighted:

‘We find that these forward-looking correlations vary negatively and substantially with VIX. Overall, the mean of the 22-trading-day correlations is 0.340 and the probability of a negative correlation is 15.6%. However, for high VIXt−1 values of greater than 25%, then the mean correlation is low at 0.177 and the probability of a subsequent negative correlation is high at 36.5%. By contrast, for low VIXt−1 values of less than 20%, then the mean correlation is high at 0.415 and the probability of a negative correlation is only 6.1%.’


robert.p.balanModeratorLeaderOwnerMar 16, 2021 10:18 AM

Market is in doldrums ahead of the FOMC decision tomorrow. But there are some interesting developments in the market price action.

This seems to be NQs primary EWP schemata -- a very large inverse irregular, with an incomplete Wave +C+ I see wave 2 and wave 4 completed, with a likely extended wave 5 in the making.

Lowerlightbebeaming has a complete suit of possibilities for this evolving wave 5 at the Elliott Wave channel, and I suggest you have a look at those charts. It really is very comprehensive.

I am asking Beam to apprise us of the correct variation, when there is enough market price action to make a conclusion.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 10:37 AM

We are seeing the same wave 5 rally possibilities in RTY.

What strikes me here is that there seems to be a much larger upside potential for NQ -- which does suggest that the primary mover for the next equity market rally may be a fall in the long term bond yields, something that Mr. TK noted earlier. This was the likely outcome of the FOMC meeting speculated upon by John and Rafa as well.

As we discussed earlier, it is unlikely that the Fed will ignore this hullabaloo, when there are very simple solutions to the bond tantrum of the Primary Dealers and the US G-SIBs -- differ the re-implementation of the SLR, or modify the portion which "penalizes" US Treasury Bonds holdings altogether. It is not difficult to sympathize with the Masters of the Universe (MOTUs) with regards to the portion of the SLR that deals with the reserve buffer requirement for US Treasury bonds.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 10:53 AM

We have to define SLR for those not familiar with this term. This is Risk.net definition:

"Supplementary leverage ratio (SLR)"

"The supplementary leverage ratio is the US implementation of the Basel III Tier 1 leverage ratio, with which banks calculate the amount of common equity capital they must hold relative to their total leverage exposure. Large US banks must hold 3%. Top-tier bank holding companies must also hold an extra 2% buffer, for a total of 5%. *The SLR, which does not distinguish between assets based on risk, is conceived as a backstop to risk-weighted capital requirements."*

I capitalized the theme that sticks to the craw of the Primary Dealers and US G-SIBs (Global Systemically Important Banks). A global systemically important bank is bank whose systemic risk profile is deemed to be of such importance that the bank's failure would trigger a wider financial crisis and threaten the global economy.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 11:03 AM

Here is the rub:

Holdings of Treasury securities by the eight US global systemically important banks (G-Sibs) increased a whopping 42% over 2020 to $1.19 trillion.

Just to cite the example of JPMorgan, the largest bank in the US:

"JP Morgan disclosed the largest increase in Treasury holdings dollar-wise, of $142.4 billion (62%) to $370.4 billion. This amounted to almost 11% of its total assets as of December 31. Citi’s holdings increased the most percentage-wise, by 73% to $232.2 billion, making up about 10% of its end-year assets."

The other US G-SIBs are in a similar quandary. So if the SLR is reimposed by April 1 with no change, you have the MOTUs shedding US Treasuries, except for bond holding necessary to transact their business as Primary Dealers. That is a lot of Treasuries dumped into the market -- at the same time. Bond yields will soar to who knows how high.

Some analysts say that if the 10Yr yield goes as high as 2.00%, the Nasdaq will shed 20% of its valuation. But the capital accruing from the sale of Treasuries will likely go into large-caps and small caps -- hence the Dow and the Russell Index will soar in that event, a development already being seen in the pricing of the equity market sectors in past two weeks.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 11:09 AM

That was a simplified illustration of how the MOTUs hate that provision of the SLR. The Fed partners with the MOTUs in the process of monetizing the debt issued by the US Treasury. With more debt issuance looming down the road, the Fed and the Treasury (government) is faced with possibly much higher cost of issuing debt and the (very slim) chance that the Fed will lose money on the stock of bonds that it is keeping in its balance sheet (which was bought from the PDs, MOTUs).

Just think about that. That will need a lot of explaining to do to the Treasury, which will not get the usual year-end profit remittance from the Fed.

So Tim and I believe that the Fed will follow the line of least resistance -- suspend the re-implementation of the SLR, while they find ways to lessen the onus of that provision hated by the PDs and G-SIBs.

*In reality, the MOTUs are not asking for a REPEAL of that buffer provision -- but to make the temporary adjustment to the calculation of the supplementary leverage ratio (SLR), which lowered capital requirements for top US banks, be made permanent.*

In April 2020, the Federal Reserve allowed banks to carve out US Treasuries and excess reserves from the calculation of their total leverage, which acts as the denominator of the SLR. The adjustment cut $17 billion off top lenders’ binding Tier 1 capital requirements. The relief was due to the COVUD-19 emergency, and the Fed needed the full firepower of the MOTUs to absorb the kind of monetary loosening that was going to be initiated.

That cascade of new "money" meant ballooning of bank reserves and increased market-making in US Treasuries at top banks (which means increased volume of securities bought by MOTUs from the Treasury). That exemption is due to expire on March 31.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 11:48 AM

How much value of US Treasuries will be shed by the PDs/MOTUs? In April last year, the SLR relief provision cut $17 billion off top lenders’ binding Tier 1 capital requirements. The holdings of the PD's/MOTUs are much larger now, following the massive debt issuance done by the government since April, last year. But assuming the very least, $17 billion of Treasuries will be dumped in short order. Hello, 2.0%.

bogeygolfMar 16, 2021 2:34 PM

17B isn't a lot of $ for the bond market. how much do you think that 17B has been used as collateral and leveraged up in the repo market, 2X, 5X, 10X ?

robert.p.balanMar 16, 2021 4:13 PM

Considering that debt issuance has increased by $4.75 trillion since April 2020, the SLR relief provision deals with circa $20 billion. But look at that as the least dollar value of bonds which will be sold, and which further serves as signalling device to the rest of the market. If the MOTUs are selling, then everyone in the bond market will sell -- they would be stupid not to.

On aggregate basis, US banks may dump as much as $650 billion of US Treasury debt securities in very short order. Why? US large banks will again be flooded with new Bank Reserves ("BR") due to the Treasury Cash Balance ("TCB") drawdown, which has already started.  The TCB and BR have a yin.yang correlation and proportionality (see chart below). Another $760 Billion (at least) will be drawn from this Treasury's account at the Fed by the end of June 2021, according to law.

Insofar as the SLR-required buffer provisions are concerned, bank reserves (the monetary asset closest to cash) have the same "penalty" levels versus US Treasuries -- but if push comes to shove, the PDs/MOTUs would prefer to hold reserves (it is almost cash) in lieu of Treasury securities. Out with Treasury paper, in with the bank reserves.

john.derMar 16, 2021 12:21 PM

It seems like how the Fed handles this SLR question then depends on whether they see an overheating economy or a fragile recovery as the bigger threat. CPI data last week did not indicate that an overheating economy is an issue right now. ... Latest retail data will be out at 8:30 NYT this morning.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 12:37 PM

It's all about the SLR john.der -- The PDs/MOTUs have been on a campaign to influence the Fed's stance of this SLR regulatory theme since mid-February. Every presentation the G-SIBs do to their investors, this SLR requirement is being drummed up as the biggest threat to (MORE) profitability -- they are influencing the insitutionals as well to help in the campaign modify this provision of the SLR.

The MOTUs know (I asked former colleagues still in the business) that inflation is not (yet) a real threat, and was told that the minute the Fed changes its TIPS buying pattern (and they will), the breakeven rate will collapse -- and there goes the Inflation Mania.

All the studies that I undertook suggest inflation (Core CPI/Core PCE and 5yr 5yr-inflation swap compensation rate -- the Fed's fave inflation gauge) ) will be making lows in May-June reporting (April-May in underlying data). The Fed knows that too, so any action that they will take tomorrow will not have its genesis on inflation data.

That is why I believe it will be regulation-based. Modify that regulatory onus to one that the MOTUs are happy with, and bond prices will rise and yields will fall. Why, even China is now buying new Treasuries, anticipating that change!.

vjapnMar 16, 2021 12:55 PM

Robert, To clarify, you are stating that FED is forced to act or face a sharp rise in yields. You believe they will act and as a result, NQ soars, yields drop. Wouldn’t RTY get impacted negatively in that event?

robert.p.balanModeratorLeaderOwnerMar 16, 2021 12:59 PM

Higher yields have always been favorable to the value sector relative-wise -- we have been saying and showing that for ages V.

Consider that regional banks (in the Russell 2000) have higher NIM (Net Income Margin) when long-end yields are higher, and the 3M/10YR or 3M/30Y yield spreads are wider, as consequence. The spread between short end and the long end widens greatly on steepening, making it very worthwhile to borrow short, and lend long. That is not so important to bigger city banks, but important nonetheless, as arbitrage between short and long trades present a lot more leveraged opportunities.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 1:08 PM

Now, Nasdaq is nothing more than a glorified High Yield or Junk play. Let me show me show you that.

NDX is just another form of High Yield and Junk -- falling bond yield should put it in more solid footing, and vice versa

*10Yr Yield (inverted) vs High Yield and Junk Bonds vs NDX*

robert.p.balanModeratorLeaderOwnerMar 16, 2021 1:26 PM

*So trading-wise, what do we do from here?*

"Old Nellie" (Mr. TK) says the prudent thing to do going into the FOMC is to be square. And I concur. But we have been bullish (even very bullish) for the NQ outlook. And game theory (even simple logic) suggests that inaction is not the correct Fed choice, given the potentially explosive market outcomes if the central bank botches it. So do we go long NQ into decision time?

robert.p.balanModeratorLeaderOwnerMar 16, 2021 1:32 PM

The Bossman had this to say. "There are 1040 days (assuming no holidays) that you have all the opportunity to make (or lose) money in the markets, when all the outcomes are binary (win/lose). For heaven's sake, why can't you just stay out of the trading grid for one day when the central bank makes up its mind -- as all or any outcome may be non-binary, that is, you win and/or lose) in that same, one day?" -- His words to the trading staff yesterday.

We will abide by the Bossman. We stop trading today.

vjapnMar 16, 2021 1:51 PM

Robert, I understand that NQ will benefit. My question was wouldn't RTY fall? Your chart for NQ and RTY showed both rising.

robert.p.balanMar 16, 2021 2:27 PM

I have yet to see NQ rally in that magnitude that we are envisioning, and RTY will sell-off outright. It will be a relative play -- NQ may outperform RTY, but there is no direct, immediate opposite reaction to lower yields. by RTY. RTY will not perform well, but will not sell-of large if long bond yields do decline from high levels. That has been the market reality for years.

sparketMar 16, 2021 2:57 PM

infrastructure package is all but guaranteed at this point

Senior Democrat caught on hot mic suggests bypassing Republicans on infrastructure

Citing expected resistance from Republicans, Democrats are looking at reconciliation measures to push through an infrastructure bill.

ikswo123Mar 16, 2021 3:05 PM

My understanding is reconciliation can only be used once a year. Has that changed?

samo4Mar 16, 2021 3:10 PM

i believe it can be used twice in 2021 because congres did not do budget resolution for 2021

RM13Mar 16, 2021 3:43 PM

The Congress can go around 'once a year' rule by assigning 'reconciliation' to a different year... This has happened before..

ikswo123Mar 16, 2021 4:02 PM

Great, so probably 1798 is still available for reconciliation...

gpbowen24Mar 16, 2021 7:04 PM

I believe its once a fiscal year. Which ends on Sept 30 for Federal Gov. Thus twice this calendar year

RM13Mar 16, 2021 11:20 PM

Congress can pass it anytime, assign it to 2022 fiscal year, and make it retroactive to 2021. When you make the law, you make the rules.

robert.p.balanModeratorLeaderOwnerMar 16, 2021 4:34 PM

I received a DM asking where to enter an NQ trade, despite our decision to abide by the Bossman statement about not trading until afrer the FOMC decision.

I said : "You saw the illustrations -- you do not need precise timing -- you can do it now and put a stop below 13,000 on NQM1. However, you need to watch this trade very attentively, yourself" -- that's what I said.

Actually, a stop at breach of 13,100 is optimal.

sparketMar 16, 2021 6:52 PM

In following the SLR thread, I'm confused on this point: is the Fed more concerned about maintaining the market or driving up inflation? It would seem like to me that reimposing the SLR would drive up yields and by extension accelerate inflation, yes?

robert.p.balanMar 16, 2021 7:59 PM

Driving up rates does not push up inflation -- rising rates are deflationary -- higher rates have been used by central banks for ages in containing inflation. Falling rates are are inflationary, and vice versa.

sparketMar 16, 2021 9:08 PM

Seems counterintuitive to me at first but the point makes sense. Thanks for the correction.

jonesngannouMar 16, 2021 9:13 PM

Understanding Interest Rates, Inflation, and Bonds

Get to know the relationships that determine a bond's price and its payout.

timothy.r.kiserModeratorMar 16, 2021 6:59 PM

Watch for the algo whipsaws on Fed day also. If you cannot stomach the wild swings, better to watch.

ptTL9Mar 16, 2021 8:12 PM

timothy.r.kiser as long as i know where market will be next week, i can stomach stormy seas.

john.derMar 16, 2021 6:09 PM

Fourth oversubscribed bond auction in a row.

sparketMar 16, 2021 9:44 PM

I'm trying to wrap my head around the fed's approach to inciting inflation. They will keep the overnight rate near zero for the foreseeable future. Making permanent the SLR exemption from 2020 will further depress yields (or rather avoid a yield spike due to a treasury sell off). Lower yields = cheaper money = eventual inflation, at least so the logic goes.

If I understand correctly, fiscal policy with the stimulus and eventual infrastructure spending will also create inflationary pressure. This is why Biden is seeding the conversation about tax increases, first the government spends the money into existence and then taxes it back.. aka, MMT.

john.derMar 16, 2021 9:53 PM

From my perspective, sparket , you should look at it this way: The Fed's charter is to promote maximum employment while keeping inflation at bay. They are not responsible for reducing employment or creating inflation. As a result, their reaction function is only kicked in when unemployment is unacceptable or inflation is unacceptable. Neither is even close. They want to let inflation run if it is beginning to pop up right now until, as they have stated, there is an overshoot that creates some sort of "average level" of 2% over some currently nebulus unknown timeframe.

Finally, I'd remind everyone that Powell has already been burnt once trying to tighten at the end of 2018. I don't see it happening again from him. I think the Fed is most likely relieved to see fiscal policy take over the reigns of the printing press. Now they wait for real inflation to show up before they act. .... That's my current take. We will see what happens tomorrow. ... open for commentary as always.

sparketMar 16, 2021 9:59 PM

Thanks John, this helps. I've been viewing it as if the fed is the one trying to push inflation, rather than wait and only step in once the average 2% level is attained. Monetary policy hasn't been as effective so fiscal might do the trick. Can't hurt with Yellen back in the picture either.


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