JP Morgan Chase 2015 Annual Report Download - page 21

1919
is also natural that countries with dierent
growth rates and varying monetary and fiscal
policies will have dierent interest rates and
currency movements.
I am a little more concerned about the oppo-
site: seeing interest rates rise faster than
people expect. We hope rates will rise for a
good reason; i.e., strong growth in the United
States. Deflationary forces are receding –
the deflationary eects of a stronger U.S.
dollar plus low commodity and oil prices
will disappear. Wages appear to be going up,
and China seems to be stabilizing. Finally,
on a technical basis, the largest buyers of
U.S. Treasuries since the Great Recession
have been the U.S. Federal Reserve, countries
adding to their foreign exchange reserve
(such as China) and U.S. commercial banks
(in order to meet liquidity requirements).
These three buyers of U.S. Treasuries will not
be there in the future. If we ever get a little
more consumer and business confidence,
that would increase the demand for credit,
as well as reduce the incentive and desire
of certain investors to buy U.S. Treasuries
because Treasuries are the “safe haven.” If
this scenario were to happen with interest
rates on 10-year Treasuries on the rise, the
result is unlikely to be as smooth as we all
might hope for.
Are you worried about liquidity in the marketplace? What does it mean for JPMorgan Chase,
its clients and the broader economy?
It is good to have healthy markets – it
sounds obvious, but it’s worth repeating.
There are markets in virtually everything
– from corn, soybeans and wheat to eggs,
chicken and pork to cotton, commodities
and even the weather. For some reason,
the debate about having healthy financial
markets has become less civil and rational.
Healthy financial markets allow investors
to buy cheaper and issuers to issue cheaper.
It is important to have liquidity in dicult
times in the financial markets because
investors and corporations often have a
greater and unexpected need for cash.
Liquidity has gotten worse and we have seen
extreme volatility and distortions in several
markets.
In the last year or two, we have seen
extreme volatility in the U.S. Treasury
market, the G10 foreign exchange markets
and the U.S. equity markets. We have also
seen more than normal volatility in global
credit markets. These violent market swings
are usually an indication of poor liquidity.
Another peculiar event in the market is tech-
nical but important: U.S. Treasuries have
been selling at a discount to their maturity-
related interest rate swaps.
One of the surprises is that these markets are
some of the most actively traded, liquid and
standardized in the world. The good news is
that the system is resilient enough to handle
the volatility. The bad news is that we don’t
completely understand why this is happening.
There are multiple reasons why this volatility may
be happening:
• There are fewer market-makers in many
markets.
• Market-makers hold less inventory – prob-
ably due to the higher capital and liquidity
required to be held against trading assets.
• Smaller sizes of trades being oered. It
is true that the bid-ask spreads are still
narrow but only if you are buying or selling
a small amount of securities.
• Lower availability and higher cost of securi-
ties financing (securities financing is very
short-term borrowing, fully and safely collat-
eralized by Treasuries and agency securi-
ties), which often is used for normal money
market operations – movement of collat-
eral, short-term money market investing
and legitimate hedging activities. This is
clearly due to the higher cost of capital and
liquidity under the new capital rules.