‘This is crazy’: Here is how the repo rate panic that everybody is talking about went down
The word went out even before the opening bell: the Fed had to step in.
Up and down Wall Street, phones lit up Tuesday morning as a crucial market for billions in overnight borrowing suddenly started to dry up. What had begun on Friday, with tremors inside U.S. short-term funding markets, was escalating rapidly.
At a small broker-dealer in New Jersey, Scott Skrym could sense the money draining away.
Not since the 2008 financial crisis has a spike in money-market rates caused such a stir — or prompted such a response
“This is crazy!” Skrym exclaimed. A key interest rate — one the entire marketplace was now fixated on — was shooting to as high as 10 per cent. That was four times its level a week ago.
Not since the 2008 financial crisis has a spike in money-market rates caused such a stir — or prompted such a response.
From New York to Chicago to Los Angeles, major banks, corporations and investment firms struggled to get answers about what is usually a simple question: Where is the overnight repurchase rate, the grease that keeps the vast global financial system spinning? Rumours flew. Wall Street dealers scurried to protect their clients — and themselves.
Inside the Federal Reserve Bank of New York, the powerful markets group had already been canvassing dealers about lending rates. By 10:10 a.m., after an initial, embarrassing misstep, the Fed was pumping US$53.2 billion into the market to calm nerves and regain control over interest rates — its first intervention since the dark days of Bear Stearns, Lehman Brothers and the rest.
The whirlwind day left traders with a host of questions, including the big one: Now what? Shortly after 4 p.m., the Fed announced it would intervene with another repurchase operation on Wednesday.
“Today was a bit of a watershed event,” said John Fath, managing partner at BTG Pactual Asset Management.
Overnight financing is a basic function, but it’s so sensitive that many Wall Street dealers and corporate treasurers decline to talk openly about it. Privately, market participants likened the events of the past few days to to a plumbing problem — the result of forces that, for most people, are largely hidden from view.
Unlike in 2008, Tuesday’s abrupt rise in short-term rates wasn’t evidence that the financial system was in trouble. Rather, it was the result of a confluence of forces, including corporate tax payments and big Treasury auctions and, ultimately, the swelling U.S. budget deficit.
Mark Cabana, head of U.S. interest rate strategy at Bank of America, saw it coming. He warned in a Sept. 13 note that the so-called dollar funding markets were about to be tested.
Corporations had to withdraw cash from money market funds and bank accounts to make quarterly tax payments, while Treasury buyers had to settle up with Uncle Sam for recent purchases. On Friday alone, about US$20.4 billion flowed out of money-market funds, according to Peter Crane, president of Crane Data LLC.
Such technicalities aside, the developments nonetheless showed the Fed was losing control over short-term lending, one of its tools for implementing the monetary policy that helps guide the entire economy.
The market was so topsy-turvy that the effective fed funds rate rose, even as economists predict the central bank will reduce the benchmark at its policy-making meeting on Wednesday.
The tumult also points to another worrisome sign: Wall Street is struggling to absorb record sales of Treasury bonds and bills that the Trump administration is using to fund a growing budget deficit. What’s more, many dealers have curtailed trading because of reforms implemented after 2008, making markets more prone to volatility.
Tuesday’s intervention marked the culmination of days of growing strains. Everyone knew pressure was building, said the head of rates financing at one major bank. But few expected a spike like this.
By early Tuesday morning, dealers were whispering that the overnight repo rate would open at about 6 per cent, well above the 3.5 per cent where it had closed the night before.
It was even worse than the dealers had feared
As usual, Robert Sabatino, global head of liquidity at UBS Asset Management, was making daily calls to check that counterparties were executing transactions at the prevailing market rate. Some of them were quoting 3 per cent. Sabatino knew the clearing rate was much higher — between 5 per cent and 6 per cent.
“It’s normal price discovery, but now complicated when the market is in flux,” he said.
Then, at 7:38 a.m., the bid-ask spread flashed on dealing screens: 8 per cent – 6 per cent.
It was even worse than the dealers had feared.
The message was clear: the Fed would have to step in like it used in the days before the financial crisis
The repo rate kept rising, eventually reaching as high as 10 per cent. By 9 a.m., a half hour before the stock market was to open, the fed funds rate was bumping up against the Fed’s upper limit.
The message was clear: the Fed would have to step in like it used in the days before the financial crisis. At 9:17, the Fed confirmed what everyone already suspected: it would conduct an overnight repurchase agreement operation from 9:30 to 9:45. The move would inject as much as US$75 billion of liquidity into the market.
Then, messages began flying across Wall Street. Rumours swirled that the Fed operation had been abruptly canceled. Only this wasn’t a rumour: the Fed was having technical problems.
The timing was horrible. New York Fed President John Williams, senior vice president of market operations Lorie Logan and first vice president Michael Strine were all expected in Washington for the two-day central bank meeting.
With anxiety growing, the Fed bumped the time to 10 a.m. Within 15 minutes, it injected US$53.2 billion, bringing rates back down, at least for a time.
“You couldn’t have picked a worse day for this to happen,” said Thomas Simons, senior economist at Jefferies LLC.
It had been more than a decade since traders at the central bank jumped into U.S. money markets to add cash. And they seemed to get the reaction they wanted Tuesday morning, instantaneously driving down key short-term rates that had spiked, threatening to muck up everything from Treasury bond trading to lending to companies and consumers.
But the move didn’t last long.
By the end of the trading session, rates were grinding back up, prompting Fed officials to fire off a second missive late in the day: They would be back Wednesday morning to offer another $75 billion of cash.