Repo Market Madness May Not Have Been a One-Time Thing
When overnight repo rates temporarily rose from 2% to 10% in September, some dismissed the spike as an unfortunate but rare confluence of idiosyncratic circumstances. But if that makes you think the liquidity crunch was a one-time event, think again. Our October research report, Repo Ruckus Reveals Hidden Issues in Liquidity Markets, makes a good case that we may be witnessing a new and longer-term systemic problem. And while it’s not necessarily a harbinger of financial catastrophe, it may nevertheless take some time to resolve.
In the meantime, institutional cash managers should take a close look at the whys and wherefores of the September repo market madness. There are many possible reasons why this mundane market, often referred to as the “plumbing” of the financial system, seized up without warning. To name just three, a surge of quarterly corporate tax payments, large Treasury issuances, and constrained deal balance sheets added up to extra funding needs in the neighborhood of $150 billion.
At first look, it appears there was plenty of liquidity in the system to meet those needs. But like the plumbing in your house, blockages in the financial system’s plumbing apparently prevented liquidity from reaching corners of the financial markets in a timely manner. The laws of supply and demand temporarily quintupled repo interest rates, which didn’t stabilize to their normal 2% range until the Fed injected more than $160 billion into the market.
The Fed has plenty of tools to address these and other issues, but it can’t solve them overnight which is small comfort to cash managers who depend on overnight transactions.
What should you do? Start by expecting more of the unexpected. Unlike previous events when repo rates spiked above the Fed’s target range at quarter- and year-end, this episode happened mid-month in the absence of major market-moving news. And plan for a more volatile “quarterly effect,” with greater fluctuations in demand possibly stressing supplies more than in the past. Most important, take this as an opportunity to reassess the liquidity structure in your cash portfolio, and consider strategies to respond to unforeseen situations.
But I’ve only scratched the surface here. For in-depth insights into the changes impacting the repo market, and to better understand how to deal with them, download Repo Ruckus Reveals Hidden Issues in Liquidity Markets today.