(Post from Dec. 2023) Basis Trade in the News
Reposting this as a "Basis Trade" Explanation
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Good evening, savvy investors! We’re circling back to a critical post from December 2023 on the “basis trade,” a strategy that’s more relevant than ever as yields tumble and short-term funding markets show signs of stress. With bond market volatility on the horizon and a looming collateral crisis in global financial systems, this is your chance to stay ahead.
Expect SOFR rates to spike and terms like “Repo” to dominate headlines, revealing deep seated macro funding issues. Our nearly two year old analysis is your roadmap to navigating this turbulence.
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Ok you can read the old post below:
***Repost of Magnelibra Post from December 2023***
This is taken from my recent LinkedIn post where I commented the following upon the recent Bloomberg Television commentary upon the “basis trade” that we see gaining traction in news outlets recently. Here is our comment upon this and after you will see a link to the Bloomberg video:
I've traded billions of US treasury basis over my career and Bloomberg has been covering this trade lately. In regards to the basis the real issue is access to over leveraging and modern day anonymity coupled with zero firm bids or offers in the US Treasury secondary market.
Before 2005 you had to keep your bid or offer on the screen for a full second and prior to 9/11 a single player could control the box (broker voice box) and swallow as much size as one could take before releasing to other players. These features no longer exist, not to mention you have no idea of whose on the other side of your futures, before 2002 you saw every single counterparty trader acronyms and their clearing house.
I would often hit or take $25 to $50 million 10s or bonds and have to buy/sell 250 or 500 futures on the Globex screen and if I saw house 660 or 350 it would give me pause because I was buying or selling into JPM or Goldman and they always had more to go...This information was vital, if the regulators or exchanges wanted to bring transparency and integrity back to the US Treasury market they would force exchanges to give out real time counterparty trade data and force secondary bids and offers to be held on screen for 1 full second.
This would remove a lot of the games that are being played and the market to function as it once has. Now it seems a very few have the ability to put on such size that nothing matters but access to credit and funding.
These days the big funds have zero limits and bypass all the regs. Exchanges are complicit and keep everything anonymous, watch the tri party repo market and watch the convexity bid once 10yrs hit 3.25%. I think we may see 10s down 40bp in a single day because of the extreme positioning going on and NO HFT algobot firms do not provide liquidity, they have vol induced limiters, meaning if vol reaches a given threshold they refrain from any bid or offer.
The real question is what banks and funds are on the other side of this, and whose rehypothecated treasuries are at risk?
The ICBC issue in November is very concerning, I cleared them for many years and never had issues, but last months ransomware attack seems highly suspect.
Here is the link to the Bloomberg piece, Bloomberg on the Basis Trade
We know that this trade is being put on in a major way by a very few large players and some have called in to question the systemic risk that this may cause. Well we know first hand that the markets are controlled by these same players that can use their balance sheets to overwhelm any given days trading. By utilizing the Repo market big funds gain access to some very cheap funding, which allows for the massive scaling of these basis trades.
However, recently the SEC voted in favor of adopting a central clearing mechanism for a majority of US treasury trades (concessions were made of course, at the behest of most likely the same people engaging in the massive one way trade now) but legislation is not mandated till June of 2026. So what looks like great regulatory legislation on the forefront gives way to the reality that it doesn’t take place for nearly 3 years and by then who knows how things will change! Here is a link to that news post on legislation here, US news on treasury trade regulations
When we look at the US treasury basis, in particular the 30Y cash we can see that the US 30Y cash the long component of this trade vs being short futures, has been a one way trade for most of the year:
We are not sure what institutions would want to be short these cash treasuries in this environment, but when they do finally get blown out, most likely in a massive convexity bid below 3.25% in the 10Y sector, we will see a massive spike upward in this chart!
As for now here is how the US 30Y yields chart currently looks trading near 4% and the point by which the whole upside move was propelled from:
Another data point for our readers to consider is the US Treasury is issuing nearly half a trillion in debt this week, $485Bn in fact:
We originally posted this to our LinkedIn as well about the U.S. Treasury debt issuance this week:
Its not the nominal amount that truly bothers me, rather its the fact that the Federal Reserve doesn't comment upon just exactly what is the transmission mechanism by which increasing debt and refinancing said debt, both lowers inflation and increases the middle and lower classes ability to afford a general standard of living.
All of my research continues to suggest that the higher the US debt goes, the more concentrated the wealth becomes and the worse off the bottom 90% become. Its amazing to think that we have Machine Learning and Generative AI at our fingertips, yet inflation and debasement are the same tools used for thousands of years by tyrants and monarchy's. Egalitarian concepts should be promoted, yet are done so by puff piece attempts and generally become corrupted, but shouldn't we know better by now?
Marx's general theory that due to internal contradictions, a capitalist society would ultimately lead to a Socialist one. Anyone looking at America right now that doesn't recognize this is merely putting their head in the sand.
One look at the current weekly US treasury auction should be evident enough that the common person cannot even begin to fathom the relative value in their lives as to the staggering amounts of capital that currently exists, yet the majority do not participate in.
What also seems to be transpiring as the debt explodes, is that the overall risk continues to be concentrated even more tightly as the recent data shows that 83% of all deposits in the United States are controlled by just 5 banks:
So much for Dodd Frank and their deposit concentration mandates, guess everything is just a goal post to eventually be moved when ever deemed fit! Section 165 of DF put in a 10% provision for total deposit concentration, obviously its a suggested amount and not something concrete.
Another thing that caught our eye is that MMMFs (Money Mkt Mut Fnds) saw an inflow of over $1.1T this year and the banks continue to grow their deposit base as well, if deposits are rising and deposit money is moving toward MMMFs where is the extra growth coming from? Is money being removed from smaller more riskier bank's? Are risk assets being sold and safety sought in cash? Are corporations hoarding cash as opposed to CAPEX spending? What does all of this increase in deposit earning risk free interest tell us actually? Is this bullish and considered money on the sidelines? Is the majority of it encumbered and or pledged to other liabilities?
These are just a few questions we have.
Alright let’s finish up here with last Friday’s settlements and our trackers as this note is now getting too long:
No position changes on our Futures Model Tracker:
The MEGA8s are still trading below their all time market cap for now:
Ok guys we hope you had a pleasant holiday thus far and we will continue to bring you intermittent updates throughout the next week into New Year. Thank you for supporting our work and please if you can’t support us, at least think about sharing this with others that may find some utility in it or just give it a like if you can we would greatly appreciate it. Till next time cheers!
Cheers,
Magnelibra
***End of Repost***