Max Kaltman writes to me:
“Hope you’re doing well. And the craziness in the world hasn’t been affecting you too much. I know I’ve written to you about cash-treasury basis a couple of times over the years. The situation has unfortunately become somewhat more acute and has started to get wider media attention.
There are some good accounts of the issue in the media, by Matt Levine for example But, there are a few things being missed even in high quality media accounts:
- The issue is now a global one, which has not been the case historically. German bunds now trade at a negative swap spread (the yield on cash bonds is higher than on similar tenor swaps). This is a fairly recent development. It suggests the problem has shifted from being primarily a shortage of USD cash (though that is still true to a significant degree), to a global oversupply of longer dated bonds.
- A crunch in repo funding does not seem to be primarily responsible here. Balance sheet efficient methods of intermediating repo (sponsored repo) are more available now than they have been in the past. And they haven’t solved the problem.
- Permitting bond basis to fluctuate is quite pernicious. It meaningfully reduces the negative correlation between long bonds and risk assets. Meaningully reducing the attractiveness of holding them in a portfolio and increasing funding costs.
- At this point, global government debt outstanding is so large basis is so high that failing to correct this issue has a meaningful budget impact. Not only in the US, but across the Western world.
I think there is a straightforward solution: The Fed has clear cut authority to trade Treasury forwards during open market operations. Which would alleviate the pressure on dealer balance sheets, relieve market dysfunction, and help restore basis to more natural levels. And do so without relying on emergency authorities.”
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