The repo market is the essential oil that lubricates the gears of global finance. It broke down in September 2019.
Over the past few years, the Federal Reserve has been deeply involved in "the repo market," which essentially functions as the world's secured borrowing system. In the repo market, short for repurchase agreements, intricate transactions occur daily as firms exchange trillions of dollars' worth of debt for cash. The operations within this market play a vital role in sustaining the functioning of Wall Street and the broader U.S. economy.
In July 2021, the Federal Reserve established two standing repo facilities, one catering to domestic entities and the other serving international firms. The purpose was to guarantee the seamless operation of this specific segment within the financial system, which had previously blown up in the fall of 2019.
In September 2019, there was a sudden surge in overnight money market rates, primarily triggered by a substantial decline in reserves linked to the corporate tax date and heightened net Treasury issuance. While a certain degree of upward pressure on money market rates was anticipated due to these seasonal factors, the magnitude of both the rise in rates and their volatility in both secured and unsecured markets was shocking.
The Fed themselves noted-
“The fluctuations in both secured and unsecured rates on September 16 and 17 surpassed any observed variations in the past few years.”
Although the Secured Overnight Financing Rate (SOFR) had shown greater volatility in comparison to the Effective Federal Funds Rate (EFFR) and displayed some seasonality at quarter-ends, it almost never experiences fluctuations exceeding 20 basis points in a single day. On the 17th, the SOFR rate had jumped 300 basis points above the benchmark IOER in a matter of hours. To expand, EFFR is unsecured lending between institutions, and SOFR represents a compilation of several different Repo rates.
I’ll include a quote here from my piece Stuffing the Coffers for reference:
The quest for a LIBOR replacement went on until 2018 when the Fed's Alternative Reference Rates Committee (ARRC) unveiled the Secured Overnight Funding Rate (SOFR) as the new benchmark. Armed with a LIBOR substitute, regulators gradually phased out its use over the following years. Its role as a reference rate concluded on December 31, 2021, and it was entirely eliminated from all financial market applications on June 30, 2023.
SOFR is a composite of three Repo rates: deliverable GC, GCF, and Tri-Party. The deliverable GC element represents the average of all inter-dealer U.S. Treasury General Collateral trades settling in FICC. GCF, or General Collateral Finance, encompasses inter-dealer Tri-Party trades settling within FICC. The final component, the Tri-Party rate, holds significance in comprehending SOFR, as it represents the average rate for trades settling at the Bank of New York (BONY).
Anyways, let’s get back to repo.
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