23 April 2021

Investment Solutions & Products

Global

Credit Suisse Economics

Global Money Dispatch

In yesterday’s Dispatch, we described how J.P. Morgan Chase & Co. adapted CONTRIBUTORS
its role as lender of next-to-last resort during the first quarter, when sentiment
Zoltan Pozsar
turned bearish in the bond market: after years of lending reserves to harvest
212 538 3779
air pockets in the GC repo and FX swap markets, it lent collateral to harvest zoltan.pozsar@credit-suisse.com
air pockets in the specials repo market. J.P. Morgan is uniquely positioned to
serve both as a cash lender and a collateral lender, as relative to other G-SIBs,
it has the most reserves at the Fed and it also has the largest Treasury portfolio.
Furthermore, J.P. Morgan’s Treasury holdings are spread along the entire curve,
while other banks hold only specific bits of the curve (see the last chart here)
– this means that J.P. Morgan can harvest specialness across the curve, while
other banks can harvest specialness only in specific sectors. In general, the
more sectors you own, the more collateral you can lend to harvest the
sentiment of a bear market in bonds, which is the reason why J.P. Morgan’s
repo liabilities rose by $75 billion and $50 billion on a spot and average basis
during the first quarter, respectively, while other banks’ repos rose much less.
Banks are uniquely positioned to lend collateral to harvest bear market sentiment:
real money holders of bonds – bond funds and foreign central banks – aren’t
incentivized to lend their holdings to short sellers, given that would fan the sell-off
and hurt their positions; however, banks tend to buy Treasuries on asset swap and
so are agnostic about the market’s direction – they are in bonds just for a spread.
That spread can go both ways: a spread over IOR as an owner of bonds, and a
spread below IOR as a lender of bonds. For J.P. Morgan, the lending spread
was 20 to 30 bps below IOR during the first quarter, which is much better than
taking deposits at zero and parking reserves at IOR for a spread of only 10 bps
– lending bonds in the specials market is like taking deposits at negative rates,
but a bank needs to own lots of on-the-run Treasuries to be able to do that...
So here is the first of four market implications of all this: if we go from a regime
where the marginal trade was to buy bonds and fund them via FX swaps or repo,
to a regime where the marginal trade is to short bonds and source them by
flooding the repo market with cash (“turning GC into specials”), then bank CIOs
go from being marginal lenders of reserves and borrowers of GC or € or ¥,
to being marginal lenders of U.S. Treasury collateral and borrowers of reserves.
Sentiment between bond bulls and bears will shift, and those shifts will dictate
whether reserves or collateral are trading special. J.P. Morgan’s bank portfolio
is dominated by reserves, so it’s more positioned to backstop a bond bull regime
than a bear regime. J.P. Morgan might decide to trade reserves for Treasuries,
which would support U.S. rates and auctions, until the next shift in sentiment...
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23 April 2021

[Quarterly]: Does J.P. Morgan Own Too Many Reserves…

$ billion

Source: Quarterly earnings supplements, FFIEC 031, 10-Qs, Credit Suisse

[Quarterly]: …and Not Enough U.S. Treasuries?

$ billion

Source: Quarterly earnings supplements, Credit Suisse

Global Money Dispatch 2

23 April 2021

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Global Money Dispatch 3