The U.S. repo market has come under the spotlight in the past couple of days as surging short-term interest rates are causing some stress for overnight funding on Wall Street, reminiscent of the 2019 funding crisis.
A repo — or, to give its full name, a repurchase agreement — is an overnight trade in government securities where a dealer sells the securities to investors and buys them back the next day for a slightly higher price. Such trades are typically used to raise short-term capital — the dealer is effectively borrowing money overnight from investors, or lenders.
The repo market is an important facet of the short-term funding habits of banks, and stresses in the market started showing up last month following the surge in bond buying in November as increased demand for short-term repo lending led to a jump in rates.
While yields on longer-term Treasuries have continued to fall from the 16-year highs hit in October, at the shorter end maturities between 1 month and 1 year, yields remain above 5%. On the final trading day of November, yields on overnight general collateral repo jumped above 5.5% and have remained close to this high into December.
The iShares Floating Rate Bond ETF (NYSE:FLOT), an exchange traded fund that references overnight financing rates, was trading 0.1% higher at $50.65 in early trade on Tuesday.
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Market Like It's 2019?
Some analysts said the repo market was showing early signs of the funding crisis of 2019, with elevated rates and liquidity scarcity. On Sept. 17, 2019, interest rates on repos, as measured by the Secured Overnight Financing Rate increased from 2.43% to 5.25%, hitting a peak during the day of more than 10%.
Fearing that surging rates on unsecured loans between banks could lead to a full-blown financial crisis, the Federal Reserve Bank of New York injected $75 billion of extra liquidity into the repo markets, and continued liquidity injections for the remainder of the week.
The Federal Reserve linked the event to a drop in reserves due to the corporate tax date and increases in net Treasury issuance.
The latest spike, analysts believe, could be related to the Treasury pile that is mounting up as government borrowing increases at the same time as the Fed starts selling Treasuries as part of its monetary tightening efforts.
However, banks should be well armed against another potential threat to their existence. They've all passed Fed stress tests, with reserves estimated at a combined $3.4 trillion.
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