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The US repo market took center stage last Tuesday, September 17
when a confluence of factors temporarily slowed down banks' cash
spigots and drove overnight repo rates to as high as 10%, which led
the NY Fed to inject large amounts of cash into banks, through
their overnight repo facility, not seen since the days following
September 11, 2001. Unlike the calamitous events that took place
almost exactly 18 years ago to the day, last week's surge in repo
rates was not purely driven by severe macroeconomic and liquidity
concerns, but instead was more of an indication of banks' sudden
unwillingness to lend enough cash to keep up with overnight repo
financing demand due to concerns over lower than usual excess cash
reserve levels. These decreases in reserves appear to be driven by
a combination of the large amount of cash leaving banks' that day
due to (1) corporations withdrawing large sums of money to pay
quarterly taxes on the September 16 deadline date; (2) the
settlement of a large Treasury bond auction; and (3) some dealers
holding larger inventories of Treasury bonds after the prior week's
sharp sell-off in the sector. The NY Fed acted on Tuesday to
rapidly reign in sharply higher overnight rates closer to the Fed
Funds target rate by injecting $75 billion of cash into banks
through an overnight repo facility, which was last operational in
2008, that they then initiated each day for the remainder of the
week and are likely to continue in some form through October.
The disruption in the repo markets did not appear as concerning
as in 2001 or 2008, as there was no apparent sign of a credit or
market liquidity concerns like those two other periods, but it
appeared to be more of an issue with the plumbing that facilitates
the short term cash markets. The sudden decline in liquidity in the
repo markets had a direct impact on the Secured Overnight Financing
Rate (SOFR), which is the frontrunner to replace US dollar LIBOR,
with SOFR closing +283bps from the prior day's close to 5.25% on
September 17 and then down to 2.55% the next day as a direct result
of the NY Fed's intervention. The chart above is repo financing
rate data from IHS Markit that compares September 16 and 17 closing
repo rates by term and shows the noticeable increase in the
overnight repo rate and slight increases in rates up until two week
terms, which may explain the NY Fed's most recent announcement for
the opening up of multiple two week term repo facilities being
offered on specific days over the next few weeks.
It seems that the prompt response from the NY Fed combined with
a swift communication from the Alternative Reference Rates
Committee (ARRC) managed to calm down the short term financing
markets. At the end of the day, these very brief bouts of
volatility in SOFR are likely a small price to pay in exchange for
it being a much more data driven and unbiased short term rate
versus LIBOR.
Posted 24 September 2019 by Chris Fenske, Head of Fixed Income Research, Americas and
Julien Rey, Executive Director, Financial Services, Head of LIBOR Transition Program, IHS Markit
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