Yen at a Crossroads as Global Liquidity Dynamics Tighten
Members of Advanced Topics received this update on Friday, which explains why the Fed's current purchase of T-bills isn't enough.
Liquidity drains will continue this week as the Treasury settles another $62 billion in T-bills. That will continue on February 17, when it settles about $35 billion in coupons, meaning over the next week, about $90 billion will need to be raised for settlement. The bill schedule for the week of February 17 could add another $60 billion to that total. This means that, over the next two weeks, we could be looking at $150 billion in settlements. However, we won’t have full details until later this week.
What seems clear at the moment is that none of the money is coming from “cash on the sidelines” to fund the debt.
Anyway, the point is that the cash is coming from somewhere; some of it appears to be showing up on dealers’ balance sheets, which may matter if it reduces liquidity in other parts of the market, such as leverage.
Given how the stock market performed and the state of reserve balances, margin levels probably took a bit of a hit in January. I’d be shocked if they increased in any meaningful way.
It looks like the LDP will win by a landslide in Japan’s weekend election, and that probably means PM Sanae Takaichi will get to “run it hot” on the economy. The weekend USD/JPY is already trading just below 158, and the win probably means it will weaken further. At this point, the BOJ is dragging its feet, and the government is running really loose fiscal policy, so it makes total sense to see the USD/JPY rise further, and the threat of intervention really seems out of place, in my opinion. But it is clear they are worried about the 160 level.
A weekly technical chart of the USD/JPY shows why. After 160, the next level of resistance comes around 164, and that is it, because it would seem to me that 220 comes next. It certainly sounds crazy, but then again, talk of the 10-year JGB trading over 2% sounded that way a year ago, too.
Of course, the divergence between the JPY and the interest rate differential is under greater strain, given how far they have already diverged. At this point, the only things that will reverse this trend are the yen strengthening, Japanese rates falling, or US rates rising. I don’t have an answer to which one happens.
We tend to care about this only because of the impact we have seen on our own market, specifically on the direction of the 5-year cross-currency basis swap and SPY. That trend has not broken for nearly 4 years now. Right now, based on this chart, dollar funding conditions are easy, which is probably part of the reason why we have seen assets like Bitcoin and certain parts of the equity market get smashed while the broader index holds together.
If, for some reason, demand for dollar hedges changes, the flow of liquidity will change as well. Something to watch.
-Mike
Defined Terms and Jargon by Claude
T-Bills: Short-term U.S. government debt securities with maturities of one year or less, sold at a discount and redeemed at face value.
Coupons (Treasury Coupons): Longer-dated U.S. Treasury securities (notes and bonds) that pay periodic interest, as opposed to T-bills which are zero-coupon instruments.
Reserve Balances: Deposits held by commercial banks at the Federal Reserve. Large Treasury settlements drain reserves as cash moves from the banking system to the Treasury General Account.
Dealer Balance Sheets: The inventory of securities and associated liabilities held by primary dealers. When dealers absorb more Treasury supply, it can crowd out their capacity to provide liquidity elsewhere in the market.
Margin Levels: The amount of borrowed money used by investors to purchase securities. Declining stock prices and tighter liquidity can trigger margin calls and force deleveraging.
USD/JPY: The exchange rate between the U.S. dollar and the Japanese yen. A rising USD/JPY means the yen is weakening relative to the dollar.
Cross-Currency Basis Swap: A derivative that exchanges floating-rate interest payments in one currency for another. The 5-year cross-currency basis swap reflects the cost of swapping yen for dollar funding and serves as a gauge of dollar liquidity conditions.
JGB (Japanese Government Bond): Sovereign debt issued by the Japanese government. The 10-year JGB yield is a benchmark for Japanese interest rates and has risen above 2%, reflecting shifting BOJ policy expectations.
Negative Gamma: A positioning dynamic in options markets where dealers must sell into falling markets and buy into rising markets, amplifying price moves in both directions.
Intervention (FX Intervention): Direct action by a central bank or government to buy or sell its own currency in foreign exchange markets to influence the exchange rate, typically to prevent excessive depreciation.
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