Troubling: The Fed' has created hedge funds that are "too big to fall"
The Bank of International Settlements has published references to events in the US government bond market in recent months. He said hedge funds played a major part in the paralysis of this market last March. The Fed and markets are now in an "endless loop" of taking leverage
However, there is a particularly interesting part of the report - the conduct of the US government bond market. Recent hedge funds are now considered "too big to fall".
The U.S. bond market shook in March. After an initial phase of "leverage reduction" in the markets, a phase that led to a sharp fall in yields. U.S. bond yields began to plummet shortly thereafter - a move that required the Fed to intervene through bond purchases. The BIS explains that, in their estimation, the main cause of the US bond market paralysis was the need for quick leverage from some hedge funds.
We will explain: One of today's popular strategies for US hedge funds is the purchase of US government bonds and the sale of derivatives such as interest rate contracts. Profit from individual activity is relatively low, but hedge funds perform a large number of these operations. Furthermore, US hedge funds have increased their leverage by using some of the US bonds as collateral in the repo market (and taking more loans for additional bond purchases). When funding in the repo markets is paralyzed, all those funds are in trouble and are required to sell US bonds at a rapid pace.
It should be noted that this technique was very popular in the banking sector before the economic crisis of 2008, but the regulatory regulations adopted following the crisis have significantly reduced the number of such transactions in banks. However, the current regulation does not cover non-banking entities, so many entities have continued to make such transactions.
Have you heard a seller? In September 2019, a few months before last March's paralysis, an extremely unusual event occurred in the repo markets, with interest rates jumping within a day from 2% to more than 10%. Also in the September case, BIS explained that those funds played a crucial role in the breakdown of the market (full article).
BIS explains that US dealers, who need to be able to absorb large amounts of US bonds, failed to meet the burden during March. Of short-term bonds. Last March, the Fed was required to introduce unprecedented intervention that continues to this day (up more than $ 3.3 trillion in the balance sheet when the majority comes from government bond market purchases).
It is very difficult and wrong to separate the September 2019 events from the events of March 2020. Last September was a preliminary warning sign for the market. A sign of over-leveraging of radiation and liquidity distress in the system.
To date, it is difficult to see paralysis of the funding markets. Unlike the last months of 2019 and early 2020, the system today is bursting with liquidity and the Fed continues to worry about raising money. However, the chain of events raises a particularly troubling question: Events over the past year have been due to over-leveraging of hedge funds in the US. Aggravated.
The Fed is currently a captive of the markets - we have created hedge funds that are "too big to fall" in terms of the Fed and will take another risk for more profits. The Fed and the US market are currently in an "endless loop" of risk taking and leverage. It will end badly for sure, but as long as the Fed supports the market, this loop can last.
It's not just the bond market, as we've been saying for a while at Bizportal, recent increases in stocks such as Tesla (which is breaking a new record today) are mainly due to the run of hedge funds that get cheap money from the repo market and run the markets by using high leverage.
Tesla Stock Graph: The Fed currently allows hedge funds to run stocks and leverage
