Today, the conversation is around the Treasury bases trade, which we all love
talking about. It's basically when hedge funds distort
the prices between futures and the underlying treasury.
Citadel founder Ken Griffin has a lot to say on it.
Joining us now is Bloomberg Technology Basic.
He was talking to the party, really came out against it, said, look, talk to the
dealers, talk to banks, talk to those guys.
Don't look at us. He's talking his book.
On one hand, here you have Ken Griffin, you have the Citadel, the hedge fund and
Citadel Securities, which is an intermediary in Treasury market.
So they are very involved in the base trade from all angles, if you will,
here. But, you know, the interesting thing he
told the F.T., let's read exactly what he said.
He said, the SEC is searching for a problem.
And if regulators are really worried about the size of the base is trade,
they could ask the banks to conduct stress tests to see if they have enough
collateral from the counterparties. Why do we love this idea?
The banks are already facing stress test number one.
And number two, it's amazing to most people on Wall Street how opaque the
Treasury market is when it comes to leverage under the system, when it comes
to clearing on all parts. There's a lot of discussion around
central clearing. There's a lot of discussion around why
the base this trade can so easily become a trade that's levered to 100 to 1.
There's a counterpart here. This is also a trade that is also put on
in part by a Treasury short or a future short.
Remember, those trades already require a certain degree of collateral here.
We also know that regulators are thinking about broader haircuts from the
banking system. So one part of that trade could require
more margin as well. So there's a lot that's potentially
changing here about the trade. And what Griffin is saying is the onus
on the banks and the banks are co-equal. The SCC should have more clarity here,
surely. Is there any way of looking at the banks
and getting an idea how big their exposure is?
You if you look at the prime operations, do we is there a way of determining,
even with retrospect, what their potential exposure could be?
The complication here, guy, is that repo financing to finance this trade doesn't
always come entirely from the banks. Some of it comes from the banks and they
usually come from different banks. So, you know, you could have a trade
where Goldman and Barclays are on one side, but then sponsored repo, where is
essentially coming from the money market system is supporting some of this trade
as well. So all in all, it's really hard for
banks even to see the entirety of the trade.
I will say when you look at those record short positions that the hedge funds are
putting on, banks will even tell you right now that that number doesn't
really tell the whole story. A lot of that positioning is supporting
the basis trade and therefore it looks very exacerbated when you look at that
Treasury short position. And not to mention some people are just
betting directionally. But yes, it is hard for the banks to see
the entire entirety of the exposure here.
Over time, bankers have told me they're concerned.
They're not quite concerned right now because they don't think that the basis
trade is as large as you see it in the short position of interest that you're
seeing. But it has been an issue in the past.
The Fed has had to step in repo markets at least twice because of the underlying
stress in repo markets in part of how it was used to finance this trade.
So another thing that can go from missing to is that if there is more
scrutiny, it's going to disrupt the financial system because there just
money will be taken out in different places and then that's going to harm
everything. You're kind of smiling.
Is that true? I find this part of the argument
fascinating because if you look at how much Treasury issuance is coming into
the system and this idea that foreign buyers are starting to step back, who is
the marginal buyer of new treasury issuance?
It is hedge funds, it's levered funds, and it is the retail investor, the
American household. And so if the levered funds are such a
big part of the buying story as we're thinking about more issuance in the next
even year or so, I've had one prominent trader, for example, tell me liquidity
could severely dry up into the middle of next year as you watch bank balance
sheet starts to drink, shrink only making those hedge funds even more
important. So if you think about how important the
hedge funds are into this new Treasury issuance environment, Ken Griffin is
making a point that a lot of people see as very relevant because they are the
marginal buyer in this Treasury market. And so if this trade doesn't exist,
where does the money come from? Double edged sword.
Sonali, is this going anywhere? It's exhausting.
And it's fascinating because you have the SEC looking at this.
You have the Federal Reserve looking at this.
You have the Bank of International Settlements looking at this.
You have the Treasury Department looking at this.
Pretty much every major regulator around the world has concerns.
And their concern here is not a hedge fund taking on major losses.
Their concern is fundamentally the way the plumbing of the financial system
works and what roles hedge funds and hedge fund leverage play in that.
And, you know, I think everyone can agree here some transparency at the
minimum on how it's working and where there could be hiccups is something that
could be very welcome for a lot of parts of the industry.