Repo Market Disruptions: In Reverse

For our complete archive of LIBOR analysis click here.

Fed Liquidity Infusions

It was previously reported that there were significant repurchase agreement (repo) disruptions with consequent disruptions in the Secured Overnight Financing Rate (SOFR).[1]

Explained

During the market turmoil precipitated by the pandemic, there was a natural infusion of liquidity by the Federal Reserve through the repo market.[2] These liquidity infusions also took place to deal with impact of the Great Recession.[3]

Unexplained

However, there have been largely unexplained liquidity infusions by the New York Fed in (i) January/February 2020 (prior to the pandemic)[4] and (ii) September 2019.[5]

Recent Significant Reverse Repo Activity

General Rationale

In contrast to repos, where the Federal Reserve infuses cash into the financial system, reverse repo activity typically signifies optimally functioning liquidity markets with banks, broker-dealers, and other participants providing the liquidity, temporarily reducing the quantity of reserve balances in the banking system. Other participants include, but are not limited to, insurance companies, money market funds, pension funds, and Government-Sponsored Enterprises (GSEs). It should be noted that reserve balances have recently been reduced for many financial institutions.

April 22-30

Increased Reverse Repo Activity

On April 22, reverse repos exceeded $100 billion with the average reverse repo volume being $134.7 billion during this period. Participants provided this liquidity at an overnight interest rate of 0%.

Relaxing of Existing Requirements

On April 30, the New York Fed reduced its existing requirements for reverse repo participants as follows: (i) money market funds having, for the past six (6) months (a) net assets reduced from at least $5 billion to $2 billion or (b) average outstanding amount of reverse repo transactions reduced from at least $1 billion to $500 million, and (ii) GSEs having, for the past three (3) months (a) average daily outstanding amount of reverse repo transactions reduced from no less than $1 billion to $0 and (b) average daily outstanding amount of overnight money market transactions reduced from no less than $100 million to $0.[6] Earlier this year, the New York Fed increased its per-counterparty limit for reverse repos from $30 billion to $80 billion per day.[7]

Week of May 3

Increased Reverse Repo Activity

During this week, the average reverse repo volume was $151.4 billion, with overnight interest rates remaining at 0%.

Economic Concerns

The U.S. Department of Labor’s Bureau of Labor Statistics (BLS) released a report showing that the nonfarm economy added 266,000 jobs in April. This was considerably less than the 1 million jobs that many economists had expected.

Week of May 10

Significantly Increased Reverse Repo Activity

During this week, the average reverse repo volume was $208.6 billion, with overnight interest rates remaining at 0%. This represents a 37.8% increase of reverse repo activity from the prior week.

Economic Concerns

It was announced by BLS that the consumer price index (CPI) increased 4.2% from April 2020, the highest inflation rate since September 2008,[8] when Lehman Brothers filed for bankruptcy during the Great Recession. The core CPI, removing volatile food and energy prices, had the sharpest monthly increase since April 1982,[9] during the 1982-82 recession.

Week of May 17

Significantly Increased Reverse Repo Activity

During this week, the average reverse repo volume was $293.3 billion, with overnight interest rates remaining at 0%. This represents a 40.6% increase of reverse repo activity from the prior week.

Week of May 24

Significantly Increased Reverse Repo Activity

During this week, the average reverse repo volume was $448.6 billion, with overnight interest rates remaining at 0%. This represents a 53.0% increase of reverse repo activity from the prior week.

Analysis

Other than high levels immediately before a quarter-end, these levels of sustained reverse repo activity in excess of $300 Billion have not been seen since the Great Recession.

[1] See the section entitled “Recent Fed Liquidity Infusions” in “The End of LIBOR: SOFR Volatility and LIBOR Transition,” dated November 7, 2019 (the “November 2019 Client Alert”).

[2] See “The End of LIBOR: Further Market Liquidity Issues in Light of Market Turmoil,” dated March 10, 2020, with Michael Lengel.

[3] See the section entitled “Historical Fed/Bank Liquidity Infusions – Great Recession – New York Fed Infusions” in “The End of LIBOR SOFR Updates,” dated December 27, 2019.

[4] See “The End of LIBOR: SOFR Updates,” dated February 10, 2020, and “The End of LIBOR: SOFR and Related Updates,” dated February 19, 2020.

[5] See the section entitled “Recent Fed Liquidity Infusions” in November 2019 Client Alert.

[6] See Statement Regarding Reverse Repurchase Transaction Counterparties of the New York Fed.

[7] See Statement to Revise Terms of Overnight Reverse Repurchase Agreements, dated March 17, 2021, of the New York Fed.

[8] See “Core Consumer Price Index Jumps Most Since 1982; Why Does Inflation Rate Matter?” in Investor’s Business Daily, Jed Graham (May 12, 2021).

[9] Id.