For the past two days, a usually under-the-radar part of the financial system has dominated headlines. The funding rate on collateral repurchase agreements – or “repos” as they’re more widely known – rose more than 600 basis points to an intraday high of 8.75%. The repo rate normally closely tracks the Federal Funds target rate, which was 2% to 2.25% at the time, so a spike of this magnitude is unusual to say the least. When rates spike as they did on Tuesday, it’s due to a lack of available cash to lend out. The Street’s explanation for this liquidity crunch was a combination of corporate withdrawals from money market accounts (to pay their tax bills) and institutional investors paying for the $78 billion of Treasuries they bought last week. This drove up the cost of borrowing money, i.e., repo rates.
The repo market matches up banks in need of short-term cash with banks with cash to loan out in the short term to earn interest. These interbank operations are the gears of the American financial engine and have major impacts on longer-term borrowing costs – but every so often, the engine and its gears need a tune-up.
Enter the mechanic. To calm jittery markets, the Fed injected $53 billion into the system on Tuesday – though only after some “technical difficulties” forced the cancellation of its first attempt – and said it would do the same thing on Wednesday, for another $75 billion. Almost immediately after the announcement, rates had returned to normal levels. Essentially, the mechanic stepped in, greasing up the gears of the American financial system to ensure it keeps on humming.
If this operation sounds familiar to those who survived the Financial Crisis, it’s because the last time the Fed engaged in this sort of operation was in 2008, though that liquidity crunch was caused by entirely different factors (namely, fears of bank failures causing the collapse of the global financial system). In all likelihood, the wild swings in the repo market are in the rear-view mirror for now. The Fed and others involved in the day-to-day operations ought to make sure it stays that way. Nothing sets off alarm bells quite like chaos in a massive and crucial market that makes headlines only when things go awry. Hopefully, the Fed’s recent tune-up of the financial system will keep the engine running for a few more years.
Vice President and Portfolio Manager
Active and Strategic Fixed Income Team
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