Much Ado About Nothing: Repo Rates And Doom Narratives

Oh look, the market found something new to obsessively fret about…

All the fuss is being made over the chart below which shows a “flash crash” in the overnight funding market otherwise known as the repo market.

(Click on image to enlarge)

To be honest, I’m somewhat surprised people are so agitated over this. The repo market is an abstruse corner of our financial plumbing. One that is poorly understood by most and apparently that includes the many financial journos writing hysteria-filled headlines about it.

Take a deep breath. And consider this a short and friendly public service announcement (PSA).

This does not portend doom. Just because we saw similar spikes in the overnight rate in the lead up to the GFC, does not mean this is a precursor to something similar. Like in all things, context matters.

The repo market, to put it in extremely simple terms, is a market where those who have cash can provide very short-term loans to those who need quick liquidity in exchange for safe collateral, such as Treasuries — think broker-dealers who hold lots of securities but need short-term cash loans to fund day to day operations.

The rate at which this money is lent is tied to the fed-funds rate. The fed-funds market is a market for overnight unsecured loans of reserves between banks and other parties. The Fed operates in this market by creating or destroying reserves and lending them out.

New regulations since the GFC require banks to hold a certain level of reserve balances. When the banks experience rising demand for cash relative to their reserves it puts upward pressure on the repo rate, which signals that the Fed needs to add more reserves to the system to allow things to clear.

And it’s in this that the key differences between the repo market issues of today and those that arose in the lead up to the GFC, lay.

You see, rising demand for reserves generally comes from three things (1) Transactions demand (2) Speculative Demand and (3) Precautionary demand. Here’s a clip from a recent report put out by Credit Suisse (CS) explaining the differences.

1 2 3 4
View single page >> |

Disclaimer: All statements are solely opinions and are for educational purposes only.

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.