Something funny is going on in the very short-term money market. That’s funny as in “uh-oh” rather than “ha ha”. A “repurchase agreement” or Repo is a widely-used instrument for managing cash needs in banks, corporate treasuries, government agencies, financial institutions, and the Federal Reserve. In a Repo, a party with an immediate need for cash sells a security, often a government or agency debt instrument such as a Treasury bill or note, to a counterparty, who pays in cash, providing liquidity to the seller. Under the Repo contract, the seller agrees to buy back (repurchase, hence the name) the security after a short term (often overnight) for slightly more than the funds received from the sale, compensating the buyer for the use of their funds. (This can be looked at as a kind of interest on a very short-term loan.)
This is a huge market: between US$ 2 and 3 trillion in Repos are outstanding most of the time and much of this turns over on a daily basis. Normally, the equivalent rate of interest on Repos closely tracks that of short-term money market interest rates such as the federal funds rate. If the Repo rate rises substantially, it is an indication of a “cash crunch”, where borrowers who have an immediate need for cash have to pay more to lay their hands on it. Usually the Repo market is stable and predictable, but in the last few days it’s been behaving distinctly oddly. It started in the overnight market between September 16 and 17, when a vertical spike in rates went from 2.25% to 4.75%, something rarely seen except in unusual circumstances such as the end of a quarter when corporations need to raise cash to pay taxes, dividends, and coupons on bonds.
On Tuesday, the Federal Reserve jumped into the Repo market and bought US$ 53.15 billion in Repos, which is essentially pumping new money created from pure zap into the system to provide liquidity. This didn’t seem to do the trick, and Repo rates continued to bounce around wildly, hitting as high as 10%. On Wednesday, the Fed was back at the trough, pouring in another US$ 75 billion in liquidity, in an offering where a total of US$ 80.05 billion in securities were offered and the Fed did not take them all. Then again, today, they did it again, spewing out another US$ 75 billion, with US$ 83.875 billion offered.
What’s going on? Well, it seems like there is a sudden, very large, and persistent thirst for US$ funds, which three days of pouring new funny money into the system has not quenched. In addition, today, the effective federal funds rate (the rate which large banks pay to borrow from one another or the Fed) has risen to 2.25%, well above the 2% top of the band at which the Fed planned to hold it after the most recent rate cut.
Finally, here’s another “Year of the Jackpot” chart: the difference between the effective fed funds rate and the Interest on Excess Reserves paid by the Federal Reserve on funds deposited with them by banks which are in excess of their regulatory reserve requirements.
What’s going on? I have no idea, and none of the sources I usually rely on for analysis seem to know either. We are in such uncharted territory that the financial system is prone to all kinds of curious perturbations. This may damp out and be forgotten soon (but that’s what people expected after the first day and then the second day). Or maybe it won’t. We’ll see.