Primary Dealers: these represent the large US banks (GS, MS, JPM, BoA etc) who are authorised to

participate in Treasury Auctions. They are essentially the market makers as in they enable market
participants to buy and sell Treasury stocks and they provide liquidity essentially. In 2008, they
levered their balance sheets too much so when markets dived they became impaired - then they
became heavily regulated (Basel, BIS, ECB, FED, FDIC etc) to prevent them from leveraging up.
Summary
Right now, during COVID19, there is a huge correction off the high, spreads are currently widening
(that is the difference in interest rates between treasury bonds & other bonds is widening), and
everybody is trying to sell to the dealers. So what's happening is that the dealers continue to
purchase their inventories, however in early March (A weeks after selloff began in end of Feb) their
balance sheets were too full and they could no longer continue to make markets (due to regulatory
reasons, too much inventory fucking up the ratios)
 
To enable the dealers to continue to provide liquidity to the market, the Fed is supporting the repo
markets which is essentially a credit facility for dealers. The dealers give the fed their inventory as
collateral in return for money that they can use to continue to make markets. The transaction will be
reversed in 7,14,90 days etc. However, all the other regulators would still be all over the dealers.
 
Next best thing is, if balance sheet is full, the Fed will drain it, freeing up billions of dollars for the
bank to use to continue to make markets. Quantitative Easing.
 
The heart of the problem is that prices are low right now, nobody wants to buy except for dealers.
The reason the markets haven't fallen lower is that there's no way to get out of current positions.
 
Jobless Claims expected to go up to 2.5 to 3million in the next quarter, starting March which will
come out in July

 
GS also estimates -24% GDP during the quarter. Worse than the any quarter during the Great
Depression. Single biggest contraction in US history.
 
Credit Spreads
 Spreads blew out early March, unseen off of a tight. See in GFC, we were near the
acceptance stage when spreads blew up. Today however, we are nowhere near the
 acceptance stage of the market cycle, and spreads have already blown up. Things could get
much worse.

 
 
More spreads
 CCBS is the premium that a borrower will pay to hedge their cross currency transactions.
 It is essentially a measure of dollar shortage in the market. The more negative the basis
becomes, the more severe the shortage.
 All the graphs below are metrics of liquidity in the bond market - and their all going
drastically wider
 
Repo Facilities
 In repo - Fed is taking securities off the banks balance sheet as collateral and giving them
money to continue to make markets (to be paid back later)
 Image below is a screenshot of the Fed's planned repo. Note they have limits on their
aggregate operations however ultimately, these limits do not exist. They are just numbers for
show, because ultimately, if the primary dealers wanted to borrow trillions from the Fed and
continue to make markets, the fed would love that
 In the diagram below that you can see that despite the aggressive operation limits the Fed is
running, there are many periods in which the auctions are undersubscribed i.e. Fed has
committed significant funds that aren't being borrowed by dealers.
 The reason these limits are not being tested is because of the other regulatory bodies (FDIC
etc etc) that with regulations that won't let them
 
 
 
Money Market Funds
 Fed and ECB started money market mutual fund liquidity facility (MMLF)
 Money market funds own lots of short term securities (commercial paper, short term
treasuries etc) and currently the primary dealers balance sheets are full i.e. They are not in a
position to be purchasing short-term securities
 With the shutdown in the economy, people are gonna start drawing down on their money
market accounts to pay for essentials (groceries, rents etc). There will be enormous need to
liquidate money funds. They are going up now because institutions selling out of market is
piling into them, and they own those securities, but as this drags on, money market funds will
get liquidated. (i.e. Fund redemptions - need to pull money out of the fund for investors)
 Fed is pre-empting the anticipated drawdowns that the primary dealers will face in the
money market.
 Fed announced QE - they will be draining the balance sheets of primary dealers. Several $bn
every night taken off the balance sheet of the dealers, freeing them up to keep liquidity in
money markets.
 
Wrong Prices
 The reason all the money market and repo funds aren't working is because of basic price
discovery. Prices are broken. There are no bidders.
 Three largest fixed income ETF's shown below are benchmarked to an index with a bunch of
bonds. For the first time in a while, the ETF's are trading at significant discounts to the NAV
 Telling us the ETF has liquidity, bond market doesn't. ETF is telling us that's where prices
need to be. When they get down low enough, bids will emerge
o Hence Bank index is down 50% YTD - and these charts suggest that prices need to go
lower
o Banks haven't written down their securities yet and taken the losses (i.e. Underlying
securities in the ETF's haven't been written down, but need to be)
o BANKS NEED TO WRITE DOWN THEIR SECURITIES