Repo Problem: Fed Injects $125B In Money Markets For 1st Time Since 2008 As Banks Face Sudden Cash Shortage

Repo Problem: Fed Injects $125B In Money Markets For 1st Time Since 2008 As Banks Face Sudden Cash Shortage

repo market
Photo by Pepi Stojanovski on Unsplash

The $2.2 trillion repurchase agreement — or repo market — is a corner of the markets that’s critical to the global financial system but rarely noticed by the public. That market turned chaotic this week when cash available to banks for their short-term funding needs almost dried up.

Interest rates in U.S. money markets went up more than four times the Fed’s rate to as much as 10 percent for some overnight loans, Reuters reported.

The spike in overnight borrowing rates forced the New York Federal Reserve to come to the rescue with a special operation aimed at easing stress in financial markets — its first such rescue operation since late 2008, according to CNN.

The price tag for the rescue operation was more than $125 billion over two days to prevent borrowing costs from going even higher. The effort restored some order to the short-term bank funding market, but not enough to stop the Fed’s benchmark lending rate from rising above its targeted 2-to-2.25-percent range, Richard Leong wrote for Reuters.

“That’s now 16% of the entire $800 billion bailout in 2008. Except this was used in a single day, and in a ‘non-crisis’ situation,” @Rhythmtrader tweeted.

Jim Bianco, CEO of Bianco Research, tweeted, “No one knows why this is happening. If it persists more than another day or two, it will be a problem.”

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Two coincidental events on Monday were at least partly to blame, most market participants agree, according to Leong. Corporations had to withdraw funds from money market accounts to pay for quarterly tax bills, and simultaneously, banks and investors who bought $78 billion of U.S. Treasury notes and bonds sold by Uncle Sam last week had to settle up.

It doesn’t help that reserves are at their lowest since 2011 thanks to the central bank culling its vast portfolio of bonds over the past few years.

All these factors are testing the limits of the repo market, “a gray but essential component of the U.S. financial system, Leong wrote.

The episode is evidence of cracks showing in financial markets and raises concern that the Federal Reserve could be losing its grip on short-term rates, Matt Egan wrote for CNN.

Mark Cabana, a rates strategist at Bank of America Merrill Lynch, blamed the spike in overnight lending rates on the Fed badly underestimating the amount of cash needed to keep the financial system operating smoothly.

“The Fed just made a policy mistake,” Cabana told CNN. “There is not enough cash in the banking system for the banks to meet all of their liquidity and regulatory needs. I’m not that worried, because the Fed will fix it.”

This bolsters the argument that the Fed needs to take steps to avoid more disruptions in the repo market down the road.