Thank you Meyrick. I could be wildly off base here but if HFs are short TNH24 or other treasuries by a massive amount for example, and expect the rates to rise, and the trade goes south (blows up) for them, and it is a highly leveraged trade, does this mean that their future ability to fund/buy treasuries is limited? This might imply that future auctions would be underfunded "D or F" for example? Exactly what the FED doesn't want?
Not really. The cash/futures basis is an option arbitrage on the basket of deliverable bonds. Effectively, funds buying cash basket and selling futures own a straddle on yields of the deliverables. If Treasuries blow up, or rally (either direction), the owner of the basis trade should be making money. Where the trade becomes nasty is if repo rates spike and force basis traders to exit the strategy. As repo rates spike would affect all basis traders, the losses would affect all at the same time, threatening a dumping of the trade - as happened in March 2020.
Probably nothing. As an ex-hedgie I know HFs never set out to cause chaos because they usually have skin in the game (or whatever outer covering we alien lizards hedgies use to cover our bodies). Unfortunately, the financial system has evolved as a set of ad hoc sticking plasters to solve problems that figure in regulators minds, but may only exist as theoretical embarrassments, or proof that 'something has been done'. The problem of the GFC was never, really, going to be fixed by constraining bank balance sheets. It certainly wasn't going to be solved by demanding ever-more granular detail from above on credit assessment of assets and funding. No surprise, then, that the reforms that followed the GFC hugely boosted to NBFI (non-bank financial intermediaries). Who wouldn't want to be Citadel? Not that I mind, but regulators do. The reforms were often just the screen for yet more political interference - by politicians like Elizabeth Warren. It was partly political interference which created the conditions for the GFC in the first place - through the American Dream Downpayment Act of 2003 and other 'affordable housing' initiatives, plus the inability/unwillingness to rein in GSEs. Plus, lots of other stuff (rise of China, depression of Treasury yields, Fed over-sensitivity to downturn). Sigh.
Meyrick, while I was tongue in cheek there, it has not escaped me that far too much government effort is made to show they are doing something. the Rube Goldberg nature of virtually all financial regulation these days is the problem. if I were in charge, my requirement would be that anytime there is a problem, remove a regulation or two that are driving the cause, rather than add a new one to try to fix it. perhaps that is why I will never be in charge, or maybe just one of the reasons.
Thank you Meyrick. I could be wildly off base here but if HFs are short TNH24 or other treasuries by a massive amount for example, and expect the rates to rise, and the trade goes south (blows up) for them, and it is a highly leveraged trade, does this mean that their future ability to fund/buy treasuries is limited? This might imply that future auctions would be underfunded "D or F" for example? Exactly what the FED doesn't want?
Not really. The cash/futures basis is an option arbitrage on the basket of deliverable bonds. Effectively, funds buying cash basket and selling futures own a straddle on yields of the deliverables. If Treasuries blow up, or rally (either direction), the owner of the basis trade should be making money. Where the trade becomes nasty is if repo rates spike and force basis traders to exit the strategy. As repo rates spike would affect all basis traders, the losses would affect all at the same time, threatening a dumping of the trade - as happened in March 2020.
Thank you for clarifying. There is much to learn.
what could possibly go wrong?
Probably nothing. As an ex-hedgie I know HFs never set out to cause chaos because they usually have skin in the game (or whatever outer covering we alien lizards hedgies use to cover our bodies). Unfortunately, the financial system has evolved as a set of ad hoc sticking plasters to solve problems that figure in regulators minds, but may only exist as theoretical embarrassments, or proof that 'something has been done'. The problem of the GFC was never, really, going to be fixed by constraining bank balance sheets. It certainly wasn't going to be solved by demanding ever-more granular detail from above on credit assessment of assets and funding. No surprise, then, that the reforms that followed the GFC hugely boosted to NBFI (non-bank financial intermediaries). Who wouldn't want to be Citadel? Not that I mind, but regulators do. The reforms were often just the screen for yet more political interference - by politicians like Elizabeth Warren. It was partly political interference which created the conditions for the GFC in the first place - through the American Dream Downpayment Act of 2003 and other 'affordable housing' initiatives, plus the inability/unwillingness to rein in GSEs. Plus, lots of other stuff (rise of China, depression of Treasury yields, Fed over-sensitivity to downturn). Sigh.
Meyrick, while I was tongue in cheek there, it has not escaped me that far too much government effort is made to show they are doing something. the Rube Goldberg nature of virtually all financial regulation these days is the problem. if I were in charge, my requirement would be that anytime there is a problem, remove a regulation or two that are driving the cause, rather than add a new one to try to fix it. perhaps that is why I will never be in charge, or maybe just one of the reasons.
thanks for writing, I do enjoy your stuff
C'mon Andy, that's just too sensible, and besides it threatens the rentier class, so it'll never happen.
alas, I know that
"Rube Goldberg nature of virtually all financial regulation" - love it.