Views From the Floor

Y2K, Y2K20: Spot the Difference

Since September, we’ve spent some time musing on the repo rate blowout, the Federal Reserve’s reaction and what the massive injection of liquidity might mean (our consistent conclusion has been ‘less trouble from the repo rate’).

But what happens if and when the Fed decides that the liquidity injection is no longer needed? Our attention has been drawn to the subject by two charts supplied by Bianco Research (Figures 1, 2).

Figure 1 shows the expansion of the Fed’s balance sheet in the run up to the new millennium. With fears about Y2K rife, the Fed supplied USD120 billion to the overnight repo market ahead of the New Year, between 7 October, 1999, and 7 April, 2000. In response, the NASDAQ started its uphill trek on the day the Fed opened its lending facility and plunged by about a quarter in the week after the facility closed.

We are currently seeing a similar expansion of the Fed balance sheet (Figure 3). Total Fed assets are up around USD407 billion since the September 2019 low.¹ This is made up of around USD261 billion in US Treasuries and about USD224 billion of repo agreements. With the Fed buying Treasuries, that’s paper that is no longer available to market participants, forcing them to buy other assets – as we have seen in the stock market moves recently.

The Fed also said that it would continue buying the T-bills into the second quarter of 2020.² However, the secured overnight financing rate (‘SOFR’) is behaving again, increasing the potential for the Fed to step back sooner. This may coincide with the ECB stopping its bond-buying programme, resulting in a massive withdrawal of liquidity from the financial markets.

Is history about to repeat itself?

Figure 1. Fed Supplied Repo During Y2K Fears

Source: Bianco Research, Bloomberg, Federal Reserve; as of 21 January 2020.

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As of 29 December 2000.

In USD billion	Week ended 11/9/19	Week ended 15/1/20	Difference
US Treasuries	2098	2359	261
Agency debt	2	2	0
Mortgage-backed Securities	1489	1408	-81
Unamortised	128	124	-4
Unamortised	-13	-13	0
Repo	0	224	224
S/T	3704	4104	400
Other	22	29	7
Reserve Bank Credit	3726	4133	407
Foreign currency assets	21	21	0
Gold	11	11	0
SDR	5	5	0
Treasury currency	50	50	0
Total factors supplying reserves	3813	4220	407

Source: Bloomberg, Federal Reserve; as of 22 January 2020.

Palladium and the Cycle…

Palladium prices reached an all-time high of more than USD2,500 an ounce on 24 January, extending a 4-year rally.

The recent rally has been driven not only by increasing demand (especially by carmakers, which has increased its usage in auto catalysts to meet stricter emissions rules) but also by a chronic shortage of supplies. Palladium is produced alongside platinum and nickel, which have suffered from a dearth of new projects.

This isn’t the first time palladium has been on a tear; similar moves happened during the late 1990s toward a then-record in 2001, driven again by a surge in demand for catalytic converters and amid concerns about slowing sales from key supplier Russia. And in 2008, closure of mines in South Africa caused the metal prices to soar.

While it is probably a stretch to think that palladium is dethroning copper or the yield curve as a leading indicator for the global cycle, the similarities with the 2000 end of cycle are notable to us: this is a marginal metal, with limited tradeable liquidity. And illiquid assets with compelling narratives have a tendency to get caught up in speculative excess in the late stages of a bull market, particularly when the provision of liquidity by central banks is profound.

Paladium as a Leading Indicator?

As of 24 January 2020.
Red shaded areas depict NBER recessions.

Momentum: This Time It’s … Not Different

Momentum is so... August 2019. Right?

While crowded trades are working in Europe, the correlation to European momentum has collapsed since the fourth quarter of 2019. The 63-day correlation is currently hovering around 0.1, while the noisier 21-day correlation is at its most negative since the data for popular trades became available in 2010 (Figure 5).

Since the violent rotation away from momentum towards value in September 2019, factor returns have been patchy: value has given back its gains everywhere in the world, while momentum has remained weak, particularly in Europe. But history has shown us that when the correlation of popular trades to momentum has reached such low levels in the past, momentum has, in fact, outperformed in subsequent periods (Figure 6).

Figure 5. Correlation of Popular Trades to Momentum Has Collapsed

Source: Man Group; as of 17 January 2020.

Figure 6. European Momentum Post Triggers

Source: Man Group; as of 20 January 2020.

With contribution from: Ben Funnell (Man Solutions, Portfolio Manager) and Ed Cole (Man GLG, Managing Director – Equities).

1. Between 4 September 2019 and 22 January 2020.

2. https://www.wsj.com/articles/fed-will-purchase-treasury-bills-at-least-into-second-quarter-of-2020-11570806265