The Fed’s Repo Ruckus Redux
Unnoticed by most investors, the multitrillion-dollar global repo market nearly melted down this time last year and once again this September.
This briefly caused interest rates on short-term repo loans to surge to 10% from just 2% in the blink of an eye.
This wasn’t a temporary glitch, either, according to a new report by the Bank for International Settlements (BIS). The BIS notes it’s a sign of deeper structural problems in this vitally important part of the global financial system.
What’s worse, it could happen again very soon!
At the time of the September repo rate spike, the Federal Reserve concluded that two one-off events conspired to freeze up the repo market, causing interest rates to spike.
The first was a heavy reliance on repo loans to finance the purchase of a big batch of U.S. Treasuries. But quarterly tax payments due on Sept. 15 sucked even more liquidity out of the repo market.
Now, several months later the BIS isn’t so sure about this explanation, noting in their quarterly review that:
“None of these temporary factors can fully explain the exceptional jump in repo rates.”
A bigger issue, according to BIS officials, is that the entire repo market relies heavily on just four too-big-too-fail U.S. banks: JPMorgan Chase, Bank of America, Citigroup and Wells Fargo. These banks “hold about 25% of the reserves in the U.S. banking system but a whopping 50% of the Treasuries,” reports Bloomberg.
That mismatch likely played a much bigger role in holding up the movement of cash into the repo market when it was most needed, according to BIS.
And not only did the repo rate spike come as a complete shock to the Fed and financial markets, but the Fed was unable to calm markets as quickly as it had hoped.
Before the September repo ruckus, the Fed was shrinking its balance sheet of Treasury securities. This means draining liquidity from the system. But in October, as a result of the repo rate spike, the Fed abruptly did an about-face and began adding reserves to the system with overnight loans and longer-term repo operations, of which have continued on a daily basis.
Could this all happen again, seizing up money markets in the process?
We may all find out soon enough, because year-end liquidity needs are traditionally when we get the most pressure on the repo rate.
Here are two important dates to keep an eye on, according to Bloomberg, because they’re fast approaching:
- “The first is Dec. 12, when the Fed will publish an updated schedule of its liquidity operations. These will be essential to easing any pressures that emerge.”
- “The next important date is Dec. 15, when quarterly corporate tax payments come due.”
Dec. 15 is also when a new round of tariffs on Chinese imports are due to take effect.
Markets could be quite volatile indeed over this week and into next.
Stay tuned for ways to keep your money later this week.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch