Don’t Fear the Repo?
September 26, 2019
The Fed had to intervene in the Repo markets last week for the first time in a decade, causing half the market to wonder why this happened and the other half to wonder what the Repo Market actually was. Essentially it is a collateralised loan market where those needing short term liquidity effectively sell safe assets with an agreement to repurchase, or Repo, those same assets a short time later. Usually this is overnight, but can be longer. Last week demand exceeded supply to such an extent that non collateralised loan rates hit 10% and the Fed stepped in to provide liquidity itself, via three $30m tranches of two week repo.
On the one hand the explanations for this spike seemed plausible if prosaic – a lot of liquidity is taken up around end quarter, with Banks hoarding liquidity while companies need it for tax filing, the Treasury have been taking liquidity into its General Fund at the Fed rather than letting it flow into the banking system and so on. Nothing unprecedented though, but perhaps the fact that Oil prices had just spiked so dramatically suggesting someone may have a big margin problem, or indeed that the cause of the spike, the attack on the Saudi Oil installations also had the effect of chocking off the daily liquidity that the Saudi’s get from the Oil markets could be sufficient to explain the move? Perhaps, but not really enough in my view, especially as the Fed had to return again this week, in even bigger size.
There is a suspicion that someone out there is hurting badly, the notion that after a lot of little fish a ‘whale’ is due to come to the surface and certainly market history tends to suggest this sort of ‘explanation’. If true then we have to hope it is dealt with quickly and effectively. A certain “Continental” bank with a market cap of around $14bn but a derivatives book of $1.5trn is appearing in a lot of conversations. I am not in a position to judge, but then again I wouldn’t be going anywhere near those types of company in any event.
More broadly this points to some bigger issues. How does the Fed shrink its balance sheet without choking off liquidity generally? Especially when the US Treasury has resumed large scale debt issuance further reducing market liquidity? How can we avoid permanent price distortions of QE? Will we ever get back to ‘normal?’