The latest from first boston’s Poszar — agree or not, he’s a clear voice with some interesting perspectives …
…Sometimes the story is a shortage of local currency collateral – today’s problem in Europe. We know why: governments did not issue enough debt, the ECB bought too much, reducing net supply via QE, and it topped it up with TLTROs. The ECB’s liquidity downpour inflated the size of banks’ balance sheets, and so banks have to “hustle” more to shrink their balance sheets into year-end to minimize their resolution fees that largely depend on their deposit base. Banks trying to push wholesale deposits away leads to a collateral shortage in German and French bills, and the ECB’s upsized seclending didn’t do the trick.
This week, the collateral shortage in Europe spilled over into the FX swap market: on Tuesday it became cheaper for a euro deposit holder to pay a premium and swap euros for dollars and buy Treasury bills with those dollars than to buy German bills (see the second chart). The year-end turn in the FX swap market is now being driven by the collateral shortage in Europe – it’s still a bid for dollars, like it was the case with Japan, but it’s driven by a money market investor, not a capital market investor, and the issue today is not a substitution of dollars, but a substitution of “parking space” for euros. Unless the ECB “nudges” foreign central banks to sell German and French bills and move their proceeds to the deposit facility, or it starts a reverse repo facility for non-banks and/or issues ECB bills, the three-month €/$ basis (OIS-OIS) could gap to -80 bps.
More HERE.