Credit and funding markets have been pretty much defined by “dollar” behavior for most of March in the same manner that defined December and early October. At the outset, it looked as if credit markets had turned the “other” way with interest rates rising and some of the downstream “markets” no longer under such steady pressure. The culmination of that was March 6, that payroll Friday which gave us a huge selloff in UST.

At the time, it looked very much like the lack of bids in the treasury market was due to dealer resources being tied up by the massive corporate issuance that week. I still think that is the case and offers at least a compelling, if partial, explanation. Further review and subsequent data, however, argue for incorporating a wider perspective.

ABOOK March 2015 Liquidity WTI Spot

There is no doubt that whatever hit that Friday was gone by the following Monday, March 9, as all the prior trends suddenly reversed. The 10-year and 5-year treasury yields that had been rising fell backward, and sharply, once again in Monday trading.

ABOOK March 2015 Liquidity USt

The effects were also felt across funding markets, too, as the eurodollar curve flattened out once more starting March 9 – to the point now that the curve is back down to its existence at the end of the last liquidity event.

ABOOK March 2015 Liquidity Eurodollars Recent

If recent history proves to be useful at predictions, or at least in this case defining what just happened, then there would likely be a repo component especially at the outset. That has been the defining feature, especially in the domestic end of the “dollar’s” train of disruption, as a surge in repo fails has almost always preceded these types of trends. In that sense, repo markets are the “ground zero” of liquidity, or illiquidity as it were, with collateral damage (pun intended) forcing outward from there over time (that third dimension of liquidity that is not always appreciated).

Unsurprisingly, then, sure enough there was a sharp rise in fails the last week in February followed by an even larger surge (the largest going all the way back to last September, preceding the October 15 event) the week of March 4 – the same week as the payroll Friday selloff that reeked of illiquid market conditions.

ABOOK March 2015 Liquidity Repo Fails RecentABOOK March 2015 Liquidity Repo Fails Longer

Swap trading has also been indicative of reduced proclivity to extend risk absorption (one function of 21st century liquidity), as swap spreads have been more unstable and prone to large swings. Further, the divergence between the 5-year and the 10-year echoes the same pattern from just prior to the October 15 event (visually below, where the green line gains consistent separation above the red line).

ABOOK March 2015 Liquidity Swap Spreads Recent

These facets of wholesale funding are well beyond (and before) the corporate issuance of the week of March 6, so there must be some other factor draining dealer capacity. Of course, illiquidity manifests in either direction (or any direction, in a three dimensional system) which doesn’t necessarily mean that the selloff on March 6 was the primary interpretation of that. In other words, it’s not so much that interest rates rose and investors sold treasuries but rather that any marginal increase in activity, even minor, caused asymmetry.

So the fact that the outcomes across the board moved in the opposite direction the following Monday only furthers that three-dimensional trend – almost like the path of least resistance as credit and funding markets, the “dollar” complex, simply took illiquidity back into the familiar trappings of prior episodes. Nominal yields fell, swap spreads widened, and the eurodollar curve flattened.

In addition, curiously, repo rates (at least as defined by DTCC’s General Collateral indices) suddenly surged. GCF rates had been volatile, to be sure, but starting around March 11 and March 12 all three classes (UST, MBS & Agency) saw their benchmark shoot up to the highest rates (outside of quarter-ends) since October 2013.

ABOOK March 2015 Liquidity GCF Rates LongerABOOK March 2015 Liquidity GCF Rates

That conspicuous surge ended on March 18, which just happened to coincide with the release of the FOMC’s “dovish” (as it was widely taken) statement. That would seem to suggest that nervousness about what the Fed might do has played a role in at least setting some of the illiquidity of late; a point echoed by swap trading where swap spreads on the 5-year jumped to 28 bps that same day.

ABOOK March 2015 Liquidity Swap Spreads

That means a confluence of trends, from structural problems over the longer run to near-term difficulties about trying to define the heaviest monetary policy (hopefully, but not likely) of our lifetimes. The results of the FOMC statement again suggest, strongly to me, that these “markets” find no positive outcome here; if the Fed does end ZIRP then the entire funding complex will have to find itself dealing with a very uncertain and rising rate environment(poisonous to intended, by policy, function) or take further confirmation that the economy is still awful. There is an edge to market liquidity that has only been so razor thin in times of serious distress, which puts the huge flattening in the yield curve and the collapse in oil prices into the same “dollar” bucket.

To me, this all suggests further reductionism in terms of systemic liquidity. Capacity is clearly constrained by related factors that have been apparent since the early months of 2013. In other words, there was an inflection, a further paradigm shift from QE-driven function and only artificial liquidity to a non-QE function of attrition since, in the all three-dimensions, there was never going to be a non-violent “exit” (the defining interpretation, I believe, of November 20, 2013). The point that needs to be emphasized here is that it doesn’t take much to send “dollar” function into deeper spasm and at least intermediate disarray (though that is a relative judgment; just ask Brazil). Back in terms of repo fails, I still wonder if absent the 3% fail penalty repo function would appear outwardly as bad as the period prior to Bear Stearns.

ABOOK March 2015 Liquidity Repo Fails Longers

Under such conditions, wide and volatile moves should not be surprising, nor should the sustained dysfunction. The “rising dollar” denotes a serious shift in presence all across the wholesale system, which means that “tightness” is not solvable through any operational means; and the action around March 18 and the FOMC statement shows that mere psychology (the bulk of intended lifting in monetary policy) is likewise ineffective. This will only end when banks decide that the world may not be so bad after all, or in a full-blown break. March seems to indicate further along toward the latter and still, after sixteen months and endless promises otherwise, not really much about the former.