It really does not get more boring that the repo markets (Repurchase Agreement).  But the repo market is a vital, yet not always well understood, part of the U.S. financial system.

Simply put, the repo market represents a liquid, efficient, tested and safe way for firms to participate in a short-term financing arrangement, providing funding for their day-to-day business operations.  It allows major financial institutions a way to function and adhere to funding requirements on a day-to-day basis.

So why should we be concerned with the repo market now?  Chaos deep inside the U.S. financial system has thrown policymakers an unexpected curveball.

Cash available to banks for their short-term funding needs all but dried up on Monday and Tuesday, and interest rates in U.S. money markets shot up to as high as 10% for some overnight loans, more than four times the Fed’s rate!  That’s right…10%!

That forced the Fed to make an emergency injection of more than $50 billion, its first since the financial crisis more than a decade ago, to prevent borrowing costs from spiraling even higher. It will conduct another one on Wednesday.

How is this happening?  It is not exactly clear, but here are some of the factors.

Most market participants agree that three coincidental events on Monday were at least partly to blame.

One, corporations had to withdraw funds from money market accounts to pay for quarterly tax bills (corporations pay taxes?).

Two, on the same day the banks and investors who bought the $78 billion of U.S. Treasury notes and bonds sold by the Treasury last week had to settle up.

Three, the reserves that banks park with the Fed and are often made available to other banks on an overnight basis are at their lowest since 2011 thanks to the central bank’s culling of its vast portfolio of bonds over the past few years.

That’s a pretty fragile course of events that quadrupled one of the most stabble asset classes on the planet.  The Fed is going to have to take a hard look at this and ensure we don’t have issues like this again.

Follow me on Twitter @MikeShorrCbot

about the author:

Mike Shorr

Since 1994, Michael has been an on-the-floor market maker, Vice-President of Interest Rate Derivatives for Knight Financial Products and Director of Education and Options Instructor at Trading Advantage. He makes the oftentimes complex world of options and trading accessible to the novice and advanced trader alike. Michael has a Bachelor of Science degree in Statistics and Finance from the University of Illinois Champaign-Urbana. He presently is Director, Trader Education at ProsperTradingAcademy.

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