Repo Creepo

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.

Overnight REPO rate, 2019-09-17

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.

Federal funds rate - Interest on Excess Reserves

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.

10+

Users who have liked this post:

  • avatar
  • avatar
  • avatar
  • avatar
  • avatar
  • avatar
  • avatar
  • avatar
  • avatar
  • avatar

Author: John Walker

Founder of Ratburger.org, Autodesk, Inc., and Marinchip Systems. Author of The Hacker's Diet. Creator of www.fourmilab.ch.

21 thoughts on “Repo Creepo”

  1. The Saudi oil fields were attacked on September 14. This started September 16. I am not saying correlation equals causation, but could the attacks require quick cash to repair them?

    2+

    Users who have liked this comment:

    • avatar
    • avatar
  2. Seawriter:
    The Saudi oil fields were attacked on September 14. This started September 16. I am not saying correlation equals causation, but could the attacks require quick cash to repair them?

    I have no idea.  I wouldn’t expect that to create an immediate cash crunch in U.S. companies, as you’d think it will take some time to assess the damage and plan for reconstruction.

    Meanwhile, here is The Economist’s Certified Conventional Wisdom™ which just came to hand.  They state:

    Fortunately, the Fed’s interventions seemed to work. The repo rate returned to its usual level, close to the federal funds rate, which in turn is within the range targeted by the Fed. Even so, the turmoil raised questions about how it plans to handle future cash shortages.

    I’m not sure that is consistent with today’s third consecutive intervention in the Repo market, which seems to have occurred (based on the Repo rate chart in the article) after it was posted.

    Chuck Butler, who writes a daily commentary for The Aden Forecast (who took over subscriptions to the International Harry Schultz Letter when Sir Harry retired) has this to say (my excerpts),

    Even though the Fed injected newly printed dollars into the Repo market the other day, the lack of dollars continues to be a problem here… It’s a real credit crunch going on and will soon turn to an all-out Liquidity Crisis… The Fed could step in at any time and calm the markets, but other than injecting a large sum of dollars late last week, they haven’t done a thing… But they will… you can count the chickens on that thought, because the Fed always knows best, right?

    My old CFO used to say… “Liquidity is not a problem, until it is”… I think it’s become one folks… and once it sets in… it could very likely be the snowflake that causes an avalanche for the economy… I’m just saying…

    You know… I was really surprised to see that the Fed Chairman, Jerome Powell, didn’t mention the cash liquidity in the repo market, not once during his press conference following the rate announcement…  What’s up with that? This is a real problem folks, and he doesn’t even mention it? I shake my head in disbelief…

    Liquidity is real Bear when it’s no longer present in a market…  And so far the Fed’s reaction is akin to having the same effect as removing a bucket of sand from a beach!

    There is a lot of speculation that there may be another round of “Quantitative Easing” (money printing) coming before the end of the year.  That is the most obvious response to a slowing economy and immediate palliative to a liquidity crunch, and would a move toward Trump’s expressed desire for interest rates of zero or below.

    2+

    Users who have liked this comment:

    • avatar
    • avatar
  3. 10 Cents:

    drlorentz:
    I’m thinking of how to make a quick buck out of this. If you can’t beat the grifters, join ’em.

    How many people have been joining you?

    I’m putting everything into Ratcoin.

    1+

    Users who have liked this comment:

    • avatar
  4. drlorentz:

    10 Cents:

    drlorentz:
    I’m thinking of how to make a quick buck out of this. If you can’t beat the grifters, join ’em.

    How many people have been joining you?

    I’m putting everything into Ratcoin.

    No one has lost money by doing that. (Did I put in “yet”?)

    I want to be be made Chancellor of the Ex-Checker.

    1+

    Users who have liked this comment:

    • avatar
  5. Darn, I had been checking into Ratburger to find out what this was all about and it turns out even John Walker doesn’t know.  That is not reassuring.

    2+

    Users who have liked this comment:

    • avatar
    • avatar
  6. The Federal Reserve Bank of New York has just issued a press release announcing that daily interventions in the overnight Repo market of “at least US$ 75 billion” will take place between Monday 2019-09-23 and Thursday 2019-10-10 and that, in addition, three 14-day Repo purchases of “at least US$ 30 billion” will occur next week Tuesday 24, Thursday 26, and Friday 27 September.

    New York Fed Repo announcement, 2019-09-20

    The announcement states that:

    After October 10, 2019, the Desk will conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined.

    So, in other words, not only is this a promise to inject “at least” US$ 75 billion of funny money into the short-term money market every business day for the next three weeks, but to continue this “new normal” afterward to suppress rates on overnight Repos so as to not exceed the fed funds rate.

    I have still not heard a persuasive (or even plausible) explanation for what has caused this sudden demand for US$ liquidity.  The Repo market almost entirely seized up in the 2008 crisis, but that’s because nobody trusted counterparties to pay them back.  There is no other indication of such a confidence crisis today.

    1+

    Users who have liked this comment:

    • avatar
  7. It doesn’t appear to be just you and I who are puzzled at what’s going on in the Repo market.  According to a ZeroHedge post, “A Clueless New York Fed Is Examining Why Banks With Excess Cash Failed To Halt Repo Panic”, in an interview with the Financial Times (subscription required), John Williams, president of the New York Fed, said “The thing we need to be focused on today is not so much the level of reserves [held at the Fed]. It’s how does the market function.”  In other words, why banks which have more than adequate excess reserves on deposit at the Fed were not motivated to enter the market to meet the demand as interest rates on overnight Repos popped up above those they were receiving on their excess reserves.

    ZeroHedge asks (emphasis in the original), “[J]ust what are the big, well-funded banks so afraid to share some of their liquidity with their less fortunate peers? What do they know that we — and the NY Fed — don’t?”.

    1+

    Users who have liked this comment:

    • avatar
  8. John Walker:
    It doesn’t appear to be just you and I who are puzzled at what’s going on in the Repo market.  According to a ZeroHedge post, “A Clueless New York Fed Is Examining Why Banks With Excess Cash Failed To Halt Repo Panic”, in an interview with the Financial Times (subscription required), John Williams, president of the New York Fed, said “The thing we need to be focused on today is not so much the level of reserves [held at the Fed]. It’s how does the market function.”  In other words, why banks which have more than adequate excess reserves on deposit at the Fed were not motivated to enter the market to meet the demand as interest rates on overnight Repos popped up above those they were receiving on their excess reserves.

    ZeroHedge asks (emphasis in the original), “[J]ust what are the big, well-funded banks so afraid to share some of their liquidity with their less fortunate peers? What do they know that we — and the NY Fed — don’t?”.

    I have seen other puzzled analyists.

    It seems that a level of unease about smaller banks and smaller agencies and corporations is warranted, but it does not seem warranted in the very short-term timeframe.

    1+

    Users who have liked this comment:

    • avatar
  9. This may be dumb, but could this be a sign the economy has expanded beyond the money supply? As an economy grows more money is needed for the extra goods and services on the market. If the money supply does not expand then the value of goods and services drop. (If an extra 1000 widgets are available, but there is no increase in the money supply, then the price of widgets drops by n/(n+1000), where “n” is the original number of widgets. This is true, even if the extra 1000 widgets are desperately needed because money available is fixed.)

    If the growth of the economy has been understated over a period of time the result is the type of liquidity trap this seems to be a response to. If the extra money is created, but there is no serious inflation results, this likely is the cause. We will have to see what happens.

    0

  10. Seawriter:
    This may be dumb, but could this be a sign the economy has expanded beyond the money supply? As an economy grows more money is needed for the extra goods and services on the market. If the money supply does not expand then the value of goods and services drop.

    The money supply, as measured by the M1 Money Stock, has continued to grow at a pretty steady pace since 2010, as you can see in this non-seasonally-adjusted chart.  (The thickness of the line is due to the absence of seasonal adjustment.)

    M1 Money Supply

    While the economy has been growing, so has the money supply, and it’s not obvious why there would be a  crunch at this time.

    Perhaps more relevant to short-term liquidity is the Federal Reserve balance sheet.  As the Fed reduces the assets it’s holding, this drains liquidity from the system.  Here is a chart from 2000 through last Friday.

    Federal Reserve balance sheet: 2002 to 2019

    As you can see, the Fed has been drawing down the balance sheet over the last two years, and this can have the effect of reducing liquidity, and has been mentioned as a possible contributor to the recent crunch.

    However, what’s odd is that excess reserves of banks deposited with the Fed,

    Excess reserves at the Fed, 2008-2019

    while declining over the last five years, are still more than US$ 1.2 trillion, much larger than the apparent liquidity shortfall of around 80 billion we’ve seen last week.  So, the puzzle, as stated by the New York Fed president in comment #15, is why the banks holding these deposits weren’t enticed into the Repo market the moment the yield exceeded what they could earn on deposits with the Fed.  For the moment, that appears to be the central mystery.

    2+

    Users who have liked this comment:

    • avatar
    • avatar
  11. John Walker:   [paraphrasing the NY Fed]:
    why the banks holding these deposits weren’t enticed into the Repo market the moment the yield exceeded what they could earn on deposits with the Fed. [?]

    Maybe the bankers were all so absorbed in the NYT attack on Justice Kavanaugh that they just didn’t notice that higher rates were available.

    2+

    Users who have liked this comment:

    • avatar
    • avatar
  12. All the puzzlement tells me that no one really understands the monetary system. The fact that we have more than a half-dozen measures of the money supply adds to the confusion. This goes along with my opinion that macroeconomics is bunk.

    5+

    Users who have liked this comment:

    • avatar
    • avatar
    • avatar
    • avatar
    • avatar
  13. drlorentz:
    All the puzzlement tells me that no one really understands the monetary system. The fact that we have more than a half-dozen measures of the money supply adds to the confusion. This goes along with my opinion that macroeconomics is bunk.

    The only safe currency is Ratcoin. “If you can’t trust a rat who can you trust. “

    5+

    Users who have liked this comment:

    • avatar
    • avatar
    • avatar
    • avatar
    • avatar

Leave a Reply