What's Going On?

Bloomberg reports Overnight Funding Rate Surges to Record Levels.

U.S. money-market interest rates surged for a second day Tuesday as cash reserves in the banking system remained out of balance with the volume of securities on dealer balance sheets.

Amid the squeeze, the effective fed funds rate rose to 2.25%, in line with the top of the Federal Reserve’s target range of 2% to 2.25%.

The rate on overnight general collateral repurchase agreements soared by more than 600 basis points to 8.75%, based on ICAP pricing, before settling back around 7.25%. Surges are commonplace only around quarter- and month-end, so market participants had expected things might return to normal.

On Monday, the rate on overnight GC repo soared by as much as 248 basis points to 4.75%, the highest level since December, according to ICAP pricing, amid the settlement of Treasury coupon auctions and the influx of corporate quarterly tax payments, possibly aggravated by last week’s bond-market selloff, in which investors sold securities back to dealers.

Separately, the Secured Overnight Financing Rate, which is backed by overnight GC repo transactions, rose to 2.43% Monday from 2.20%, New York Fed data show. That’s the highest since July 31.

Federal Reserve Injects $75 Billion Into Financial System

The Financial Times reports Federal Reserve Injects Billions of Dollars Into Financial System

TD securities points the finger at bank reserves.

We think that the culprit is the scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity. Reserves have been declining since 2014 and we expect them to decline further as Treasury’s cash balance increases and currency in circulation grows.”

The Fed seems to have fixed whatever the problem was with the $75 billion injection. Repo rates are back down, for now.

Technical Factors

A reader commented: "Analysts said there were technical factors squeezing the repo market rather than the systemic issues that drove overnight rates much higher during the financial crisis. Now what are the technical factors?"

Sometimes there is an end of month squeeze but this happened on Sept 16 and again September 17.

"This mid-month surge was attributed to a confluence of events that knocked cash reserves in the banking system out of balance with the volume of securities on dealer balance sheets: a corporate tax payment date, settlement of last week’s Treasury auctions, and last week’s bond-market sell-off, in which investors sold securities back to dealers."

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Wall Street Journal Chimes In

The Wall Street Journal reports Fed Steps Into Repo Market to Control Soaring Rates

Scott Skyrm, a repo trader at Curvature Securities LLC, said he had seen cash trade in the repo rate as high as 9.25% Tuesday. “It’s just crazy that rates could go so high so easily,” he said.

On his trading screens, Mr. Skyrm said he could see traders with collateral securities that they were trying to exchange for cash. The rates they were offering would start to rise until an investor with cash available to trade would start to accept their bids, gradually driving repo rates down until investors had exhausted their cash, he said. Then rates would resume their climb.

While there are technical factors to explain why cash would be in high demand this week, including corporate tax payments, the settlement of recently issued Treasury securities and the approach of quarter-end, they didn’t seem to explain the “crazy market volatility,” Mr. Skyrm said.

It seems like there’s something underlying out there that we don’t know about,” Mr. Skyrm said.

Bottom Line

Someone was in serious need of cash and got it.

Mike "Mish" Shedlock

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