Allowing money managers to jump into its repo operations would be a useful contingency for the central bank in times of stress, said Wrightson ICAP economist Lou Crandall. “Whether the Fed wants to do that in the ordinary course of business is another question,” he added.
Looser Rules
Even though Treasuries became exceptionally difficult to trade in March, that isn’t to say that primary dealers shirked their market-making duties. The surge in trading revenue last quarter across the large banks -- including a record for JPMorgan -- suggests a big engagement, and daily average volume catapulted to an all-time high exceeding $1 trillion in early March.
But primary dealers have to manage their own risks in a crisis, said Kevin McPartland, director of market structure at research firm Greenwich Associates.
“The fact that the Fed had to intervene at the level that it did tells you there were obviously liquidity issues. We heard anecdotally from the asset mangers there were definitely some challenging moments,” he said. “For market makers and even primary dealers, while their job is to help the markets continue to function, their job is not to catch the falling knife.”
Wall Street has long lobbied against post-2008-crisis regulations that banks say have constrained their market-making function. JPMorgan Chief Executive Officer Jamie Dimon said as much in an October earnings call to explain why the bank didn’t lend into the prior month’s repo turmoil.
Indeed, one solution the Fed landed on in March to unclog the market was to relax the supplementary leverage ratio, effectively freeing up space on dealer balance sheets. The Fed might consider extending that forbearance.
“I’m not going to be surprised if things don’t improve at the end of March 2021, to see that rule extended or made permanent,” said Alex Li, U.S. rates strategist at Credit Agricole SA.
That seems quite possible as the Fed reviews how the guardrails put in place over the past decade have served the system in its first crisis since then. For policy makers, there’s a balance to be struck between loosening the leash in a crisis and ensuring dealers are maintaining appropriate buffers in more peaceful times.
Lift The Rope
But for some, adding more primary dealers is a better solution. The New York Fed hasn’t signaled an intention to revise its trading relationships or further expand its primary dealers circle, and it declined to comment for this story. But it has long experimented with the terms of its closest dealer relationships.
In the 1940s, the Fed tightened its inner circle to an 11-strong band of “qualified dealers” that it kept on a short leash in a restricted market, where U.S. interest rates were capped at low levels to finance the war effort. A subcommittee tasked with reframing that role in 1954 noted that “privilege as such is repugnant to the spirit of American institutions.” The qualified-dealer status was scrapped, and for several years the club had no specific membership criteria.