The repurchase market (or “repo market” as it is commonly referred to) is one of the largest markets in the world with over $2 trillion of daily transactions. It underpins much of the financial system, impacting everything from the trading of stocks and bonds to lending and hedging, yet it is probably one of the least followed areas of the market as it is very predictable and a somewhat boring market. That was until recently when repo rates unexpectedly surged, igniting painful memories of the liquidity issues during the Financial Crisis. However, unlike during the Financial Crisis, we believe the current spike in repo rates does not pose a systemic risk to the financial system as the primary driver behind the spike is due to temporary technicals.
Normally, the financial markets operate with a lot of excess cash (or liquidity) within the system. Two situations occurred the week of September 15th that resulted in a temporary cash shortage, leading some market participants to pay elevated yields to obtain cash.
- $78 billion of Treasury issuance settled the week of September 15th, resulting in cash exiting the system to buy these securities (The Wall Street Journal).
- September 15th was the tax deadline for corporations that filed a 6-month extension. As a result, many corporations pulled cash out of the system to pay their tax bills with $20.4 billion in outflows from money markets on the Friday prior to the deadline (MSN).
We see these two factors that led to the cash shortage as only temporary and the Federal Reserve has stepped in to provide liquidity to participants in need of cash at the appropriate interest rate and there should be no long-term, permanent implications.
Please check out our infographic explaining more about the repo market, why repo rates recently surged and what is being done in response to the increase in rates.