The March 2020 episode of market turmoil and lessons for future financial stability
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The March 2020 episode of market turmoil and
lessons for future financial stability
Anil Kashyap
University of Chicago Booth School of Business
July 7, 2020
The views here are my own and not necessarily shared by the Bank of England’s
Financial Policy Committee. Thanks to Geoff Coppins, Lee Foulger and Bernat Gaul-
Ricart for helpful conversations on these matters.
Outline • Dislocations during March • Interlinkages across markets • Policy implications
The speed and size of sales of US Treasuries challenged dealers’
intermediation capacity…
US equity prices and bond yields Primary dealer net inventories of US Treasuries
Per cent UST 10y yield (RHS) Basis
S&P 500 (LHS) points
9 Mar 15 Mar
5 10
0 -10
-5 -30
-10 -50
-15 -70
-20 -90
-25 -110
-30 -130
-35 -150
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20
Sources: Bloomberg Finance L.P. and Bank calculations. Displayed as changes year to date. The aggregate net inventory (long minus short) of primary dealers, maturity weighted by multiplying the
net position in dollars by the number of years to the centre of each reported maturity class, to roughly
reflect the sensitivity of market values to changes in yields.
Source: Federal Reserve Bank of New YorkThe stock of marketable Treasuries has grown significantly relative to dealer balance sheets Source: Duffie (2020) Still the World’s Safe Haven? Redesigning the U.S. Treasury Market After the COVID-19 Crisis
…and impaired UST market functioning, which only normalised
after Fed action
Basis Basis
UST 30y bid/offer spread (RHS) UST 2y cash-futures basis (LHS)
points points
140.00 15 Mar: USD swapline rate and 3.2
maturity enhanced
120.00 23 Mar: Federal 2.8
100.00 Reserve 2.4
announces further
80.00 measures 2
60.00 1.6
40.00 1.2
20.00 0.8
0.00 0.4
-20.00 0
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20
Sources: Bloomberg Finance L.P, Eikon by Refinitiv. and Bank calculations
Note: The bid/offer spread is a 5-day moving average.
Latest observation: 18 Jun 2020 (27 May 2020 UST 10y cash-futures basis)Funding costs in USD increased, and only fell back once the Fed
introduced central bank swap lines
Dollar swaps outstanding
Onshore and offshore rates for 3m dollar funding
Other Bank of Canada
OIS +[25bps to 50bps] Swiss National Bank Bank of England $ bns
Central bank USD swapline rate Bank of Japan European Central Bank 700
Onshore via USD LIBOR Per cent
Total
3.5 600
15 Mar:
20 Mar: Swapline
Swapline rate and 3.0 frequency 500
maturity enhanced 20 Mar: Swapline
2.5 increased 400
frequency increased
2.0
300
15 Mar:
1.5 Swapline rate
and maturity 200
1.0 enhanced
9 Mar 100
0.5
0
0.0 2007 2009 2011 2013 Mar 20 Apr 20 May Jun 20
Feb 20 Mar 20 Apr 20 May 20 Jun 20 20
Sources: Bloomberg Finance L.P. and Bank calculations
Note: Offshore funding calculations use FX swaps referencing 3 month Libor. The dotted light blue
line indicates that prior to the 15 March 2020, swap lines were only offered at a 1-week, not 3 Sources: Bloomberg Finance L.P. , Federal Reserve and Bank calculations
month, maturity. Note: Other includes the Reserve Bank of Australia, the Banco Central do Brasil, the
Latest observation: 18 June 2020 Danmarks Nationalbank, the Bank of Korea, the Banco de Mexico, the Norges Bank, the
Reserve Bank of New Zealand, the Monetary Authority of Singapore, and the Sveriges
Riksbank.
Latest observation: 11 Jun 2020A similar dynamic was seen in the UK gilt market, which also
became impaired, and normalised after the BoE’s QE…
Gilt yields Bid-offer spreads on gilts
5 year 10 year 30 year Per cent 5 year 10 year
Basis
30 year points
1.6 4
19 Mar: BoE package 19 Mar: BoE
1.4 package 3.6
(Bank rate cut 15bps
and additional £200bn 1.2 3.2
asset purchases) 1 2.8
0.8 2.4
2
0.6
1.6
0.4
1.2
0.2 0.8
0 0.4
-0.2 0
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20 Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20
Source: Bloomberg Finance L.P., TradeWeb and Bank calculations Source: Eikon by Refinitiv
Latest observation: 18 June 2020 Data up to: 18 June 2020…and in sterling money markets, which became stressed and only
stabilised when the BoE launched QE and liquidity support
Sterling money market spreads MMF outflows and assets
Overnight reverse repo - Bank rate spread Basis £ Per
3-month reverse repo-OIS spread ‘Dash for cash’
points billions cent
3-month £LIBOR-OIS spread 24 Mar: CTRF
270 4
announced 100
19 Mar: Further BoE 260 3
package 31 Mar: 80
2
Quarter- 250
60
end 1
40 240
0
20 230
-1
0 220 -2
-20 210 -3
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20 Mar 20 Apr 20 May 20
Source: Bank of England Sterling Money Market data collection and Bank calculations. Sources: Crane Data LLC and Bank calculations
Notes: The overnight reverse repo rate is for cleared DBV (Delivery by Value) transactions. The 3-
month reverse repo rate uses only transactions estimated to be non-nettable (under leverage ratio
rules). Both rates are volume-weighted and are stated from the perspective of dealers.
Last observation: 18 June 2020During the market stress in March, ‘flight to safety’ movements
widened the spread between IG bonds and government bonds…
Basis
points
Non-financial corporate investment-grade spreads
500
400
300
200
100
0
1/1/2020 2/1/2020 3/1/2020 4/1/2020 5/1/2020 6/1/2020 7/1/2020
GBP IG USD IG EUR IG…and dealers stopped absorbing US corporate bonds, and shed
some of their inventory, leading to higher trading costs
Cumulative inventory change (USD billions) in the
Transaction costs in the US corporate bond market
dealer sector and as a fraction of total supply
Primary Dealer
Credit Facility
announced
Primary and Secondary Market
Corporate Credit Facilities announced
Source: Corporate Bond Liquidity During the COVID-19 Crisis (Kargar et al)Interlinkages across markets
What were the market interlinkages in March’s ‘dash for cash’?
Large margin calls on derivatives forced funds and …and withdrawals from money market funds and
insurers to raise cash through repo or bond sales… other open-ended funds added selling pressure to
asset markets and money markets.
Bond liquidation
The usual stabilisers in government bond markets did not work as leveraged
investors were forced to sell, and dealers became overwhelmed by selling
pressure.
Bond market illiquidity Funding illiquidity puts
spreads to funding pressure on bond markets
markets
As bond prices fell and became …which forced more of the
volatile, it became difficult and investors trying to raise cash to
expensive to repo… sell bonds.Policy implications
What could be the policy implications of March’s ‘dash for cash’? • If central banks step in during stress to backstop financial markets, is greater resilience in markets need (via regulation or market reform)? Which markets should be covered? • How should the financial system best adapt to a world where markets may not be able to rely on dealers to maintain levels of liquidity at all times and other intermediaries are involved in market making? • If even sovereign bonds can become illiquid, what does that mean for banks' liquidity regulation? • Do we need to change MMMF regulation to ensure that MMMFs retain cash like properties even in stress?
Further reading
Further reading on March’s ‘dash for cash’ • BoE – Interim Financial Stability Report May 2020 • Jon Cunliffe, Deputy Governor, Financial Stability, BoE – • “Financial System Resilience: Lessons from a real stress” • Andrew Hauser, Executive Director, Markets, BoE “Seven Moments in Spring: Covid-19, financial markets and the Bank of England’s balance sheet operations” • BIS – Annual Economic Report 2020
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