JPM on Ukraine vs. Lehman, Liquidity
J.P Morgan's latest "Short-Term Market Outlook and Strategy" discusses "Precautionary liquidity" over the invasion of Ukraine. They write, "Price action in the US funding markets was volatile over the past week. The announcement of the sanctions on Russia unleashed fears of a funding crisis possibly similar to those in September 2008 and March 2020. On Monday, spreads in the FX and cross-currency basis markets opened sharply wider, as did the CP/CD market. But while the FX and cross-currency basis markets retraced nearly all of their spread widening by week's end, funding costs in CP/CD continued to climb.... In contrast, price action in the repo markets was stable." The piece tells us, "While it's tempting to compare the events of this past week to prior liquidity crises, we believe the sharp rise in funding costs is not a reflection of a lack of liquidity in the marketplace. In fact, there is plenty of it, as evidenced by the $1.5tn at the Fed's RRP and $4tn of reserves sitting on bank balance sheets. Prime MMF AUMs also held steady at $800bn, an indication of stable liquidity. That is, shareholders are not running for the exits as we saw in 2008 and 2020, which resulted in a massive pullback in USD lending. Instead, the price action of this past week is a reflection of precautionary liquidity. As we noted previously, we believe the direct linkages between Russia and the financial markets are limited, though we acknowledge there could be more exposures beyond what the Central Bank of Russia and BIS tell us. According to our European bank equity strategists, their initial assessment is that Russia is not a capital at-risk event, equal to about 5-10% of Lehman risk, even with their expectation of losses to come.... As a result, they believe the overall capital impact from higher Russian provisioning remains manageable." Authors Teresa Ho, Alex Roever and Holly Cunningham continue, "Even so, rising geopolitical risks and the potential impact on banks from a capital and earnings perspective are prompting banks to preemptively raise more funding. Moreover, even given the course of events this past week, the Fed seems set on tightening and draining liquidity (albeit from high levels). Overall, banks are being prudent by actively raising excess cash, with a focus on term. This is particularly the case among the Nordic and Canadian banks.... Unfortunately, the sudden increase in term funding was met with an investor base that has been defensive since the start of the year, and remained so as they tried to assess the economic implications in the US and what those might mean for the Fed. Indeed, prime MMFs have been shortening their WAMs since the beginning of the year on the prospect of a potential 50bp hike.... Chair Powell's testimony this week confirmed this is unlikely in March, but left the door open for more aggressive action down the road. Furthermore, the rapid ascent in yields over the past 6 months is already having an impact on portfolio NAVs as they trend closer to par.... As a result, there is limited interest for investors to commit out the curve (1y SOFR FRNs widened 20bp week over week) and risk a further drawdown in NAVs. Looking ahead, until we see more clarity with the situation in Ukraine and the sanctions on Russia, the need for banks to raise term funding might persist." They add, "That said, we think the knee-jerk reaction to raise term funding at once might be behind us, as we're seeing signs of stability in the FX and cross-currency basis markets. We're also starting to see money market investors being more opportunistic with term trades. Still, it might take a few more weeks for spreads to stabilize as we head into a period of high bank CP/CD maturities and quarter-end."
