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A little over two years ago, on the 11th anniversary of Lehman's bankruptcy, a "repo crisis" shocked Wall Street when on Sept 16, 2019 it suddenly became apparent that despite $1.3 trillion in "excess" deposits and years of QE, there was not nearly enough liquidity in the system. A month later we were the first to piece together the puzzle, which confirmed that it was JPMorgan's drain of over $100 billion in repo and money market liquidity that was the precipitating factor for the repo market collapse. In other words, not only did JPMorgan spark the repocalypse (it was not just us who made this claim, but other websites and news sources), but with its actions also triggered the launch of the repo liquidity flood and, a few week later, the $60BN in "NOT QE" T-Bill purchases, aka QE4 which would just months later be followed by the Fed's mega bazooka as Powell went all in to save the world after the Covid collapse.
But while it was JPMorgan's direct actions that soaked up enough liquidity from the market to start a cascading crisis, the actual trades in question were highly levered positions involving a relative-value compression trade in the Treasury cash/swap basis, similar to what LTCM was doing ahead of its 1998 bailout (we described this dynamic in detail in in Dec 2019 in "The Fed Was Suddenly Facing Multiple LTCMs.")
For those who missed it, a quick refresh: for much of 2017, 2018 and into 2019, as volatility collapsed, one increasingly popular and extremely levered hedge fund strategy involved buying US Treasuries while selling equivalent derivatives contracts, such as interest rate futures, and pocketing the arb, or difference in price between the two. While on its own this trade is not very profitable, given the close relationship in price between the two sides of the trade. But as LTCM knows too well, that's what leverage is for. Lots and lots and lots of leverage...
To read more visit Zero Hedge.
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