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Repo Market

The repo market (short for repurchase agreements) is vital to financial markets and is often referred to as the plumbing for the entire financial system.

The focus was supposed to be the Federal Reserve meeting, but the spotlight quickly shifted to oil and money markets that surged early in the week in two unrelated incidents. The Fed proceeded with their largely expected quarter-point rate cut, but there was divide among policy makers on whether a cut was needed. U.S. economic data came in strong this week curbing recession fears among a backdrop of concerns over slowing global growth. There was a lot to unpack, but it is worth shedding some light on the Repo market that is one of the lesser known constructs of the financial system.

Weekly Returns

S&P 500: 2992 (-0.51%)
FTSE All-World ex-US (VEU): (-0.71%)
US 10 Year Treasury Yield: 1.74 (-0.16)
Gold: $1,515 (+1.81%)
EUR/USD: 1.1018 (-0.51%)

Major Events

  • Monday – Brent crude oil jumped 15%, the most on record, after an attack on Saudi Arabia’s oil industry Saturday cut their output by half.
  • Tuesday – Short-term funding rates spiked as high as 10% due to liquidity issues that prompted an emergency cash injection from the Fed.
  • Wednesday – The Fed announced a quarter-point rate cut to its benchmark overnight lending rate bringing the target range to 1.75% – 2%.
  • Thursday – The Organization for Economic Cooperation (OECD) cut its global growth forecasts to the slowest pace since the financial crisis.
  • Friday – President Trump announced sanctions on Iran’s central bank and sovereign wealth fund in retaliation for the attacks on Saudi Arabia’s oil facilities.

Our Take: What is the Repo Market?

The repo market (short for repurchase agreements) is vital to financial markets and is often referred to as the plumbing for the entire financial system. Leaks in the piping surfaced this week prompting the Fed to inject large amounts of cash into the system to address the sudden liquidity dry-up and help calm markets.

Massive amounts of cash and securities used as collateral change hands in the form of short-term loans that keep the piping of the financial systems flowing smoothly. One party lends cash overnight in exchange for interest. The loan is secured by collateral that the other party agrees to purchase back the next day in exchange for returning the borrowed cash. Institutional market participants like banks and hedge funds use the repo market as a source for funds to buy U.S. treasuries and other assets while money-market funds and corporations use it as a safe place to park their cash.

What Caused the Volatility in the Repo Market?

Investors were unsettled by the volatility that drew comparisons to Lehman Brothers during the onset of the 2008 financial crisis. The good news is, this is not that. The moves in the repo market were similar in action, but the underlying causes were much different here. In a Bloomberg Opinion article, ex-New York Fed President Bill Dudley offered his take on what unfolded this week and said “don’t worry, the Fed can handle it.” Dudley cited a few key reasons behind the moves:

  1. The central bank’s recent pairing back of the securities portfolio
  2. The September 15th deadline for paying corporate taxes required companies to pull cash
  3. The settlement of a large Treasury auction and the high demand for cash to purchase the bonds

These factors drained reserves from the banking system by creating a supply/demand imbalance which caused repo rates to spike and even bled into the federal funds market. The takeaway is that this is most likely not the underpinnings of a financial crisis bubbling, but a useful signal for the Fed to act as it has and the need to address future structural change sooner rather than later.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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