No Super Mario
Ex-plumber gets a prize while problems in the pipework mount
Plumbing: an essential job nobody wants to spend time thinking about till there is a problem. Mario Draghi deservedly earned the sobriquet ‘Super Mario’ because of his skill in financial plumbing at the European Central Bank. In the original Nintendo game, Mario had a brother called Luigi. Today we learned that another plumber (Ben Bernanke) shared the Nobel prize for his contribution to managing bank liquidity problems, here is a quick update that suggests the Fed should beware of current plumbing issues. Unfortunately, there are no sign yet of either Luigi or Mario at the Fed.
Yes, there are other important economic/geo-political factors, but it is not unreasonable to think the terrible quarter-end price for S&P500 (and other equities) may have been affected by low liquidity. And in particular, low liquidity in settlement medium.
Year-to-date, Tri-party repo turnover has risen by $1 trillion, while reserves (used by FedWire) have fallen by $ trillion. Reserves in the system due to banks stood at $2.983 trillion by 28th September, the lowest level since early-November 2020.
Just at the end of September saw a rise in Tri-party repo usage of an extra ~$145 billion compared to the previous week. Almost simultaneously, the week to 28th September saw the Fed report a rise of $141 billion in RRP deposits made by ‘Others’ - meaning money-market funds. So, we can tentatively conclude ~$140-145 billion in medium was not available for securities settlement in the week leading up to the latest quarter-end.
FedWire is used to settle all manner of financial transactions between US banks. And reported turnover between risky assets and daily volumes of FedWire are particularly high. US equities turnover (ADV) show a high monthly correlation to ADV of FedWire of 84% going back to Jan-2019.
Of course, there is some elastic limit to the settlement process; settlement is possible in-house between clients at banks, for example. But the safety of reserves is a big factor between banks, and that requires FedWire.
What marks out end-September behaviour is the combination of
rise in RRP levels,
a pronounced fall in repo levels (reflecting surplus cash from money-market funds) and
pressure on equity markets.
The pressure on repo suggests banks are increasingly unwilling to accept deposits over quarter-end, which, all things equal will continue to place upward pressure on the quantities RRP and downward pressure on available reserves for FedWire. Maybe September 2022 is a one-off. Maybe not.
September 2022 is a first time repo, RRP and equity prices have moved together at quarter-end in such a co-ordinated way. Sure, there are other things to that provide explanation. But we need to be aware that the normal signals of financial liquidity constraints (short-end interest rates such as repo) may not be relied upon this time as an early-warning signal for problems in the plumbing. And there is no ‘Super Mario’ around either.