The Repo Market: Do Americans Actually Understand How It Works?

September 18, 2019 | Guest Contributors, Insights
https://dailyalts.com/wp-content/uploads/2019/09/53e7dd4b4355b114a6d98074cf213576083edbe35b59734c702c73_640.jpg

The Repo market is back in the headlines… but did anyone notice on Monday?

This morning, while doing my best to follow the news around Iran and the United States, I had to gloss over MSNBC and CNBC to discover something far more important.

I turned on Bloomberg News, which gave me hot flashbacks to intense finance courses in graduate school. There is a level of discussion on Bloomberg that is almost too difficult to understand at 8 in the morning when you have a toddler.

But the discussion turned to Repo markets.

While Bloomberg analysts and guests didn’t seem too alarmed around recent developments, I became alarmed because ordinary people once again have no idea what is going on in the most important lending markets in our economy.

It’s the element of information inequality that continues to plague societies. Bloomberg analysts were talking about the repo markets like two people in a bar might talk about a baseball game.

The only difference is that everyone in the bar actually understands the rules of baseball.

Repo markets might as well be the moon to the barflies.

And perhaps to a lot of colleagues in the media.

The Fed’s Decision

In a little while, we’re going to receive some insight from the Federal Reserve on interest rates.

It’s not so much the cuts that I’m very concerned about. It’s the statement of Jerome Powell… and Repo markets.

The Federal Reserve cannot be indecisive about the future. The market wants accommodation.

While all the chatter is about the Fed’s benchmark rate, we’ve seen a brand-new curveball on rate decision day.

Over the last two days, the Federal Reserve Bank of New York has stepped in to offer emergency cash injections into the financial system. The reason: Cash that is available to Fed member banks completely dried up on Monday and Tuesday.

It pushed up interest rates for money markets by double-digits in some cases.

This morning, that critical lending rate actually traded above the Fed’s target rate of 2.00% to 2.25%.

The fact that we’re seeing banks experiencing a cash crunch is alarming.

We can blame the fact that companies withdrew money to pay quarterly taxes.

And we can say that last week’s $78 billion bond sale by the U.S. Treasury required the banks to pay.

But we can’t excuse away the fact that the repo market is flashing a big red sign about banking reserves.

The repo market is like water

Repo trades are the repurchasing of bonds by Wall Street companies and banks who have used these securities as collateral to raise cash for lending activities.

These borrowers then buy back the bonds the next day at a nominal interest rate.

Fear – the ultimate tool of market behavior – can fuel spikes in those repo rates if people are afraid of lending.

And when that happens, it sends a whipsaw up the credit cycle of the U.S. economy and can paralyze money flows.

For all the talk about stress tests and liquid reserves, we know that banking reserves aren’t truly reserves at all.

Back when the Fed started raising interest rates in 2015, bank reserves sat at about $2.8 trillion.

When the Fed started cutting down on its balance sheet and raising rates, bank reserves started falling rapidly.

The Fed seems to have recognized a pattern.

So, it’s been holding bonds on its balance sheet and cutting rates again.

It’s not so much about giving the economy a boost with a rate cut – like President Trump seems to imply.

It’s about providing enough accommodation to ensure that reserves remain healthy and that the benchmark rate remains in the target range.

Those reserves are the primary source of funding the repo markets and key credit operations.

If the Fed is unable to control this rate and people are too afraid to lend money again – we have a serious problem on our hands. Only this time, there’s not much that the Fed can do in terms of further cuts or adding assets.

Maybe the real lesson for me today is that I’m alarmed that Bloomberg wasn’t alarmed.

Free Industry News

Subscribe to our free newsletter for updates and news about alternatives investments.

  • This field is for validation purposes and should be left unchanged.


Alt Insights

January 29, 2020

Venture Capital: The Kobe in “Bryant Stibel & Co”

Venture Capital: The Kobe in “Bryant Stibel & Co”
Shape

Latest Alternative Investment News

https://dailyalts.com/wp-content/uploads/2020/02/57e2d64b4354a814ea898579ce203e7c1d22dfe05b53774f712e73d5_640.jpg
Private Equity Shops are Going on a Startup Spending Spree, Says Pitchbook
February 25, 2020     News, Private Equity, Venture Capital

A new Pitchbook report shows that private equity shops are snapping up an interesting alternative investment. Flush with dry powder, PE shops have been snapping up VC-backed startups, according to…

https://dailyalts.com/wp-content/uploads/2020/02/51e6dd454b52b114a6d98074cf213576083edbed5157774a702f7b_640.jpg
Activist Hedge Fund Looks to Shake Up Insurance Giant Prudential
February 25, 2020     Activist Updates, Hedge Funds, News

Activist hedge fund Third Point has taken aim at the 172-year-old insurance giant Prudential (LON: PRU). According to a new filing, Dan Loeb’s shop wants to split the firm into…

https://dailyalts.com/wp-content/uploads/2019/12/dices-over-newspaper-2656028_1920-preqin.jpg
Alternative Assets: Funds Surpass $10 Trillion In AUM in 2019
February 25, 2020     Alternative Investments, Latest News, News

A new Preqin report shows that the alternative assets industry has reached “14 figures.” Total AUM surpassed $10 trillion for the first time in 2019. The industry added at least…

https://dailyalts.com/wp-content/uploads/2020/02/money-29047_640-qcash.png
FinTech: QCash Signs Up Tropical Financial Credit Union For Small Loans
February 25, 2020     FinTech, News

QCash Financial, the US fintech and digital loan marketplace gained a major new client in Tropical Financial Credit Union (TFCU). TFCU has $700 million in assets and 65,000 members. QCash…

Scroll to Top