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A tale of two curves

By Henry Adams on 2021-03-23

In our latest commentary we discuss the recent actions from major Central Banks, the sharp rise in inflation expectations since the turn of the year, the current pressure on short-term interest rates and consequent challenges to Government MMFs and, of course, the fall-out from the Greensill Capital debacle.

Diversion is the name of the game. Since our last post we have heard from some of the key central banks regarding the steepening of the yield curve witnessed globally. Policy makers in the US, UK, Europe and Asia are mostly unphased by what has been a significant move since the beginning of the year (more on this on a per currency basis below). Stocks continue to perform well (breaking records in the US) with stimulus not being withdrawn - its early departure has long been a risk that economists and think tanks have warned against. Thus, the overall theme of recovery and growth remains in place, albeit on a regional basis as lockdowns draw closer to a close in some jurisdictions, whilst being reignited in others, feeding into projected performance. In the US alone, after what feels like a process as long as Brexit has finally been concluded, a new package to the tune of an additional $1.9Tn has now been approved. Some of this is going directly into the pockets of many Americans, and then probably bitcoin. Currencies and stocks appear to be highly vaccination-program driven right now, but nowhere is immune!

Whilst one of the great ways to reduce the debt pile might be to inflate it away, the ECB has been sure to manage expectations on the future path of interest rates. The goal is simple. To keep money extremely cheap and financing conditions as accommodative as possible. The yield on the 10 year bund is telling on some of this move though - since the beginning of 2021 the return has improved by 25bp, simplistically speaking a 25 basis point hike. The front-end though has changed little as Brussels has clearly stated that measures will be brought in, and aggressively should market rates not come down. We heard on Monday that once again the pace of net pandemic bond buying increased last week. A theme expected to continue.

Graph constructed from Bloomberg LLP

The Bank of England remains modestly positive. Whilst a great deal of uncertainty persists, by historical standards, there are reasons to be optimistic. With households and firms sitting on a cash pile now exceeding £350Bn, it is predicted that the UK will spend and invest its way out of the pandemic when restrictions ease. Clarity on the future trading relationship with the EU (which has, until now, kept company cash and planning on the side-lines), along with more than 50% of the adult population now vaccinated and furlough extended to Q4 (albeit tapered), unemployment is a problem for another quarter.

UK Treasury Bill auctions have found support at zero now and yields in the 6 month paper in particular are starting to offer a return on investment (well, 5 basis points!). On the other hand, as we drive towards quarter-end, funding pressure appears to be returning to bank balance sheets with Gilt repo trading at negative levels. Timing seems to be good on our new 1 month secured product yielding 0.10 and beating the socks off alternatives, particularly on a risk-adjusted but also outright basis in many cases.

The idea of negative rates in the UK has gone up in smoke, along with returns for holders of gilts. If you thought bunds looked like better value now, UK 10 year gilts look cheap(er). Having kicked off in 1 Jan at 17 basis points, a little under three months into 2021 the yield has risen almost fivefold. Massive moves are afoot, in particular as the Bank is taking a different stance to the ECB and letting it rip.

Graph constructed from Bloomberg LLP

Looking Stateside, one would think that if an additional $1.9Tn injection into the economy, along with more Americans now vaccinated than ever caught the virus (over the 100MM mark) doesn’t fix things, then nothing will. Rightly, the Fed is not just focussed on inflation nor expectations of it, citing the 10 million unemployed as needing to be redeployed prior to tightening monetary conditions. Inflation here, much like elsewhere, is being caveated as key to policy decisions. Fed officials are comfortable with prices rising more quickly, no doubt in part as an easier way out of repaying debt. The market also knows this and has been pricing accordingly.

It is very much a tail of two terms though. Whilst steepening of the curve is definitely a big thing from 2 years and out, dynamics in money markets have gone the other way. The pressure of more central bank money and the reduction in new issuance of treasury bills is taking its toll (see article below for more). In order to avoid buying a treasury bill at a premium to par (also known as negative yields) you now need to be looking at locking up for a minimum of six months for the first time ever. Financing of government securities has not been left unscathed and has at least for now returned to 0.00. This does bring into question how long government money market funds can stay in positive territory (think 0.01%) and avoid turning negative, given that fund complexes would typically charge 10-20bps in fees. Thankfully, we will shortly be able to deliver other solutions offering similar security in the form of ultra-short 1 and 2 week SSA FTFs.

If you were wondering what you can buy with $1.9Tn, the answer is a lot more, following a cheapening from 0.91 to 1.70 in just over 12 weeks, a staggering move.

Graph constructed from Bloomberg LLP

Interestingly we are also close to pre-pandemic levels here.

Graph constructed from Bloomberg LLP

In other news, the cautionary tale of the Greensill saga continues. It is increasingly looking like a game of hot potato. With insurance having lapsed, questionable accounting practices, creative selling techniques and more news filtering out just yesterday of the scale of losses, the winddown will be a rather long process as claims are submitted but assets are lacking. Credit Suisse has thus far returned just $3.1Bn to investors out of the $10Bn under management - the $140MM cheque that was advanced by CS as recently as last Autumn, supposedly as bridge financing to Greensill Capital’s IPO, looks likely never to be seen again; and recoveries on the billions still outstanding are uncertain at best.

There are hard lessons to be learnt here on doing one’s due diligence properly, as well as understanding that focussing exclusively on high returns may lead to no return at all if neither interest nor principal are paid when due. This is a crisis that has a long way to run and will have consequences across continents - whilst some depositors are to be protected in Greensill’s German bank, an estimated one third of deposits will not be bailed out. These were mostly placed by German municipalities that were already stretched from the additional support needed in their jurisdictions - an estimated EUR 500 million shortfall will likely weigh on the German taxpayer, one way or another.

The sad thing is that Greensill’s original core business model of supply chain finance against irrevocable payment undertakings was sound. Hopefully the industry can recover quickly from this unsightly blemish.

Articles of interest

Powell says Fed will announce update on SLR exemption in coming days

Corporate Cash Soars $1.01 Trillion in 2020 to $3.82T

The Australian underwriter who provided Greensill Capital’s lifeline

An FTF or Fixed-Term Fund is a regulated fund investment that offers exposure to a single investment-grade obligor for a fixed term, without the need for any client infrastructure. An FTF has many of the same characteristics as a term deposit, but can offer exposures outside of the banking sector. TreasurySpring is originating FTFs with sovereign, financial and corporate obligors.