Yet another scandal unfolds at the Bank of England

Sometimes the news just leaps at you off the page and overnight this has happened concerning a warning I have made in the past about the Bank of England. So let us get straight to the Financial Times on the subject.

The Bank of England has referred to the UK’s financial watchdog the revelation that an audio feed of its market-sensitive press conferences was supplied to high-speed traders before the events were officially broadcast.

This is disgraceful on two counts. Firstly in an era of computer driven algorithm driven trading an edge like this is quite something for them as we mull exactly who was more equal than others? To coin a phrase. Next is the fact that this happened at the ECB several years ago and after such a warning someone should have been dispatched to make sure that it could not happen at the Old Lady. So we can add laziness to the incompetence.

As ever the PR machine is in full flow and has opened its batting with an attempt to put the blame elsewhere.

Following a rapid internal investigation, the central bank confirmed what it called a “wholly unacceptable” use of its back-up audio feed of press conferences by a third party supplier, which it has refused to name citing legal reasons.  The BoE was responding to an article in The Times, which reported that hedge funds had been eavesdropping on press conferences a few seconds before others heard the words of governor Mark Carney.

The spinning starts with the report of a “rapid investigation” which surely is in fact a really tardy one as the ECB scandal was several years ago now! Also did no-one wonder why this was set-up?

The audio feed was installed only to act as a back-up in case the video feed failed, but the BoE said it had recently discovered — “following concerns raised with the bank” — that the feed had been misused by the supplier since earlier this year.  “This wholly unacceptable use of the audio feed was without the bank’s knowledge or consent, and is being investigated further,” the BoE said in a statement. Those who received the audio feed had a five to eight-second advantage over people who watched the main video feed, the Times reported.

Have you noted how a “few seconds” seems to have suddenly morphed into a ” five to eight-second advantage”? Also the attempt to shift blame to the supplier is really rather weak. Did nobody wonder why funds were willing to pay the amounts suggested below?

Clients were charged between £2,500 and £5,000 per press conference for access to the audio feed, the newspaper reported, adding that high-speed audio services were also offered for similar events at the European Central Bank, the US Federal Reserve and the Bank of Canada.

Even the Financial Times which like more than a few parts of the media has lauded Governor Carney as a “rock star” central banker have to admit this.

However, this is embarrassing for the BoE. Comments made by Mr Carney and other senior BoE officials at the press conferences that follow meetings of the monetary policy committee and financial stability committee often move sterling and gilt prices: having a start of a few seconds would allow traders to pre-empt the rest of the market.

As to any resolution well in true Yes Prime Minister style the ball is licked into the long grass.

On Thursday, the BoE said it had referred the matter to the Financial Conduct Authority to investigate whether rules had been broken and trading had occurred on the basis of early information from the feed.

How about yes and yes as the answers to those questions?! Indeed in the replies IronKnee seems to understand the game.

You don’t understand the system, it’s the City

We have a long investigation, then take a few traders to Court (great if they are from the EU27 or have excess melanin) because the Executives couldn’t possible know what their staff were doing and can’t be held responsible.

Indeed the higher up you are the less responsible you are for anything. Yet in other areas…..

#ECJ : An airline is liable for the harm caused by a spilt cup of hot coffee #nikiluftfahrt

Let me now link this back to my theme and what I consider to be an even more serious issue so let us step back in time to August 2nd 2018 and I have added some emphasis.

 Actually one way or another the decision has already been made as the Monetary Policy Committee voted last night. This was a rather unwise change made by Governor Carney as it raises the risk of leaks or what is called the early wire as the official announcement is not made until midday. As you can see from the chart below the BBC seems to think that the decision is a done deal or knows it is ( h/t @Old_Grumpy_Dave ).

Retail Sales

We can continue the Bank of England theme as we note that last time around 2 members voted for an interest-rate cut and would likely be further confirmed by today’s Retail Sales release.

The quantity bought in November 2019 fell by 0.6% when compared with the previous month, with only household goods stores reporting growth…….In the three months to November 2019, the quantity bought in retail sales decreased by 0.4% when compared with the previous three months; this is the first decline since April 2018.

The state of play is summed up by this bit.

There has been a slowdown in the rate of growth in recent months, with October 2019 increasing at just 0.1%. November 2019 saw a decline of 0.4%; this is the first decline since April 2018, which reported a fall of 0.2%.

Indeed the annual comparison has weakened too.

Year-on-year growth in the quantity bought increased by 1.0% in November 2019; this is the lowest growth since October 2017, owing to a decline of 1.1% in non-food stores.

So there does seem to be something going on although there is a catch as whilst the official view is that this is covered by the seasonal adjustment I am much more doubtful.

In 2019, the official Black Friday was on 29 November and outside our November reporting period, which covers four weeks from 27 October to 23 November; our seasonally adjusted estimates account for this shift in timing.

Comment

As the term of Bank of England Governor Mark Carney comes to an end I am reminded of the Yes Prime Minister view that an intelligent and honest Governor would be an “innovation”. Added to that has been the accusations that he has played politics in the Brexit debate which was frankly hardly a surprise for a man accused of playing politics when he was Governor of the Bank of Canada. Sadly such issues got covered in a smokescreen provided by a fawning media who presumably are hoping today that people have short memories.

However there are 2 deeper issues which are as follows. The Bank of England has proved to be somewhat scandal ridden as we note the Li(e)bor and various other scandals. Next is the fact that this matters ever more because central bankers have intervened in so many new areas. Indeed that has been highlighted this morning by the Riksbank in Sweden which ran negative interest-rates in a boom and now responds to rising unemployment with this.

Therefore, in line with the assessment in October, the Executive Board has decided to raise the repo rate from –0.25 per cent to zero per cent. The forecast for the repo rate is unchanged, and the repo rate is expected to remain at zero per cent in the coming years.

Yet they mostly escape criticism for this shambles. Perhaps if Governor Carney could stick to the day job that might help.

 

 

Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

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