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JPMorgan analysts say work-from-home may hit funding markets

Hong Kong

THE impact of the coronavirus outbreak on Wall Street may worsen trading conditions for one of the world's most liquid and important assets: US Treasuries.

So say strategists at JPMorgan Chase & Co, who warn that overwhelmed dealer-banks in an extreme scenario could be flooded with an extra US$200 billion worth of US government debt as market participants rush to secure extra financing. That could then challenge the repurchase market, a vital part of the financial system's plumbing, just months after the Federal Reserve was forced into actions to support it.

Global financial centres are grappling with the implications of the outbreak, with New York and London seeing "split" operations as big banks and dealers divide their workforces and instruct traders to work from home. Business-continuity disruptions could damp liquidity, contributing to extreme moves in reaction to unexpected developments and worsening what's already been a turbulent ride for investors.

"Though the world is much more focused on market risk at the moment, it is important to bear in mind that we are also in the early stages of the first large-scale operational-risk episode," JPMorgan analysts led by Joshua Younger wrote in a note. "Liquidity overall could also suffer, with some signs of emergent stress already apparent and transaction costs in even benchmark Treasuries significantly higher than even prior episodes of stress."

The analysts have been pointing to signs of strain in the US Treasury market, including wider bid-ask spreads and a rise in the general collateral rate for repo transactions. Yields on benchmark 10-year US Treasuries dropped sharply in recent weeks, reaching a record low of 0.31 on Monday as investors herded into the safety of government debt amid the worst Wall Street sell-off since the global financial crisis.

It wouldn't be the first time that liquidity - essentially a description for the ease of trading - dried up in the Treasury market. In October 2014, a sudden "flash" rally shocked traders and prompted US regulators to investigate the price action.

A disruption in the vast repo market, where Treasuries are a crucial form of collateral for loans among financial institutions, unsettled investors last September. That then prompted the Fed to unveil billions of dollars worth of liquidity support for the market, in an initiative still under way.

While many of the largest and most systemically important dealer-banks have contingency plans in place to deal with this type of disruption, the JPMorgan analysts said, smaller operators - which have become bigger players in one type of overnight repo - may be more vulnerable.

"We are already seeing market-making severely disrupted, and to the extent that logistical frictions prevent 'human' traders from providing a backstop, liquidity-transaction costs can stay very high compared to even recent history," the JPMorgan team said. "For many market participants, operationally intensive activities with limited potential upside will look far less appealing. This is particularly true of overnight repo funding."

Banks and other financial firms around the world have been reporting coronavirus cases as the outbreak which has claimed more than 4,000 lives globally spreads from China to Europe and the US. This week alone Point 72 Asset Management, Deutsche Bank AG, and private equity firm KKR & Co have confirmed cases, prompting the companies to instruct staff to work from home, or to divide up their sales and trading teams at affected offices. BLOOMBERG