Last December, something clearly broke. The global basis had swept far under zero again, an ominous sign that eurodollar banks were having trouble creating, finding, and redistributing global funding. A cross-currency basis swap is one way to do it, the negative basis indicating a desperate shortage of dollars offshore (eurodollars).
The negative basis wasn’t the only thing suggesting dramatic distress. Concurrently, the domestic repo market had exploded. Repo fails for the week of December 13, 2017, were an astounding $832 billion, the very same moment the cross currency basis (especially against euros) fell off a cliff. Our Chart of the Week for that same week essentially predicted what FRBNY would report for fails:
When the Fed a week later published the data from primary dealer call reports, the updated chart looked like this:
It all went back to earlier in September 2017. But if that was when it started, December was when it got serious. I wrote:
Just as raging wildfires have a horrific tendency to jump fire-lines and even whole valleys given enough energy, funding issues can jump markets. The global “dollar” market is not a monolithic whole and never has been. It may be (very likely is) more fragmented today than at any point in the past owing to persistent balance sheet capacity problems. It would be a clear point of magnification, then, to find serious problems in one part of the eurodollar system spilling over into another one.
On its balance sheet, a separate series, the Fed also showed that starting the week of December 13 UST’s began to disappear from its custody. The US central bank holds more than $3 trillion in such securities on behalf of overseas official and commercial institutions. These do not register within its inner workings for the Fed’s monetary purposes, merely a courtesy that gets reported to the public.
In a matter of just four weeks, by the first week in January, more than $36 billion of UST’s vanished from Fed custody. We don’t know for sure where they went, but we can reasonably assume that such a massive “silo” of the most pristine collateral (for US$ purposes) owned by foreign central banks and banks might’ve been in high demand during that time. Not for inflation hysteria and a world heading in the right direction but as collateral in short-term funding liabilities of all kinds as the global monetary system reset toward the dark side.
Another outbreak of repo fails and at the tail end of January global liquidations. It’s been much more of the same ever since – except for repo fails as reported by FRBNY.
