Nov 13, 2015 (LBO) – Several strange occurances in U.S. financial markets have raised eyebrows of market analysts amid a near-zero interest rate policy.
U.S. interest rates have been near zero, with loose monetary policy followed for nine years, on the heels of the subprime mortgage crisis during the 2007-2009 period.
This year some Scandinavian countries have recorded negative interest rates which defy long-standing banking logic that depositors would not pay a financial insitution to hold their money.
Six of these oddities, according to a Bloomberg report, are listed below.
1. Negative swap spreads. Rates charged for interest rate swaps have fallen below yields on equivalent U.S. Treasuries. This means investors are charging less to deal with banks and corporations than with the U.S. government.
2. Repo rates are fractured. As the lubricant for the financial system, repo markets allow banks and investors to exchange assets such as Treasuries and other high-quality paper for short-term financing.
Now there is no single repo rate. Different U.S. banks are showing slightly different repo constructs against the same collateral. This is after new regulation requiring that banks hold more capital regardless of riskiness.
3. Corporate bond inventories are below zero. Analysts at Goldman Sachs have highlighted that inventories of some corporate bonds held by big dealer-banks have gone negative after the Federal Reserve began collecting such data.
That means big banks are net short on corporate bonds with a maturity greater than 12 months to about 1.4 billion dollars breaking a longer-term trend of net positive positions. The trend reflects the rising cost of holding corporate-bond positions.
4. Synthetic credit is trading tighter than cash credit. Investors struggling to trade bonds with a apparent lack of liquidity have turned to alternative products to gain or reduce exposure to corporate debt.
These include derivatives like credit default swap (CDS) indexes, total return swaps (TRS) and credit index swaptions.
“In exchange for the substantial liquidity of derivative indices, investors are often giving up spread right now, as most indices trade at a negative basis versus the comparable cash market,” Barclays’ Bradley Rogoff wrote in research report.
5. Assets which are registering large moves — four or more standard deviations from their normal trading range — have been increasing. Such moves would normally happen once every 62 years.
On October 15, 2014, the yield on the 10-year U.S. Treasury briefly plunged 33 basis points — a seven standard – deviation move that should theoretically happen once every 1.6 billion years, based on a normal distribution of probabilities. Some analysts cite lower market liquidity for the wild moves.
6. Volatility itself has become more volatile. Analysts say it is hard to argue that global markets were more stressed in August than they were during the depths of the financial crisis several years back, but that’s not what the vacillations of the VIX indicator shows.
“The volatility market that exists today is much more complex than it used to be; ETFs, indices, futures, and options traded on all of the above have complex relationships that haven’t been fully tested,” George Pearkes, analyst at Bespoke Investment Group, said.
“Eventually, as we saw in the wake of last August, equilibrium is found when dislocations occur. But getting there can be complicated. Volatility, in my view, hasn’t changed. What’s changed is how it’s warehoused and shifted.”