skip navigation


Stay up to date on timely topics and market events. Subscribe to our Blog now.

September 23, 2019

Making Sense of the Repo Market Mayhem

By Kevin Kennedy

Stay up to date on timely topics and market events. Subscribe to our Blog now.

A dollar funding shortage hit markets last week as a perfect storm of factors combined to expose an insufficient quantity of cash in the system, creating severe upward pressure on overnight funding rates. While the occurrence can be viewed in parallel to the dollar demand required for balance sheets each month-end, quarter-end and especially each year-end, last week the September 16 corporate tax deadline and $54 billion in net US Treasury (UST) settlements occurred in an environment where reserve scarcity was already present due to increased UST issuance and in general an elevated level of reserves set aside by banks. Cash was drained from financial markets and the banking system as corporates took withdrawals from money market funds and banks to make tax payments to the Treasury.

The funding squeeze, which began on Monday, September 16, saw overnight repurchase agreement (repo) levels skyrocket to as high as 8.5%, and resulted in the average effective fed funds rate rising to 2.30%, above the Fed’s targeted range of 2.00% to 2.25%.

Exhibit 1: Money Market Funding Stress
Money Market Funding Stress
Source: Bloomberg. As of 18 Sep 19. Select the image to expand the view.

The pressure continued into Tuesday before the Fed took action and stepped in to offer dollar-funding liquidity by conducting a repurchase operation with the 24 primary dealers in an amount up to $75 billion. The first such operation on September 17 drew $53 billion in interest and the subsequent two operations drew strong demand in the amounts of $80 billion and $83 billion.

In the aftermath of this action the pressures on funding rates eased considerably, and markets became less concerned that the squeeze was an indication of a more broad-based problem with liquidity in the markets. On Friday, September 20, in order to ensure that significant pressures did not arise over quarter-end, the NY Fed announced that it would enter into overnight and term repurchase agreement operations through the end of the quarter and into early October.

Since the financial crisis, regulatory requirements such as Dodd-Frank and Basel III have changed the behavior of global systemically important banks (GSIBs) as they have set aside higher levels of reserves and now maintain adherence to complex capital requirements. Increasing UST funding needs, in the aftermath of the Fed’s balance sheet normalization process, have made it challenging for the Fed to determine what path to take to avoid future periods similar to what was experienced last week. In the near term, the Fed’s reserve additions via overnight and term repurchase agreements are likely to assuage fears of major funding problems at quarter-end. But with year-end fast approaching, the Fed will certainly be discussing options such as a Standing Repo Facility or a permanent addition of reserves through outright purchases of USTs.

We expect that the Fed will make it clear, however, that the tools it chooses to utilize are not related to changes in its approach to monetary policy, but rather a response to evolving technical conditions in the short-term funding markets.

© Western Asset Management Company, LLC 2021. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.