Eye-Popping Surge in Repo Rate Blamed on Rules Instead of Funding Stress
(Bloomberg) -- Costs in one of the key U.S. borrowing markets surged at the end of 2018 more than is typical for year-end, but observers say it’s mostly a result of banks tidying up their balance sheets for regulatory reasons rather than a sign of wider funding stresses.
The rate on overnight repurchase agreements soared on New Year’s Eve by more than 3.5 percentage points to 6.125 percent, a level unseen since 2001, based on ICAP pricing. While it eased on the first trading day of 2019 Wednesday to around 3 percent, the repo rate is still far from where it was before year-end liquidity issues surfaced.
A combination of factors, including the impact of regulation and banks’ increased presence within the repo market, helped to fuel Monday’s “eye-popping” move, according to Lou Crandall, an economist at Wrightson ICAP in New York. A decline in the level of bank balances held at the Federal Reserve means that financial institutions have in general increased the amount they lend in the repo market as they seek somewhere safe and liquid to park money that enables them to meet regulatory obligations. One complication is that these same banks tidy their balance sheets at year-end when regulatory surcharges are calculated. As part of their bid to lessen these regulatory imposts, banks tend to pare their exposure to repo, which in turn makes it more expensive for borrowers.
“It was an atypical but typical year-end, because bank balance sheets were even more scarce than people thought,” said Gennadiy Goldberg, a senior U.S. rates strategist at TD Securities. It “isn’t a funding issue, it’s balance-sheet scarcity that was worse than expected,” he said.
Goldberg and Crandall said overnight repo may edge lower by the end of the week.
“I don’t think it’s going to be immediate,” Goldberg said. “It takes a while for the balance sheet to come back.”
Curvature Securities’ Scott Skyrm likened Wednesday’s market action to a New Year’s hang-over, writing in a note to clients that “the funding pressure was so severe that it will take a few days to return to ‘normal’. ”
“Going forward, there is a clear need to reprice risk for rate spikes,” Skyrm said, drawing attention also to the dislocations that took place around the time of former U.S. President George H. W. Bush’s funeral last month. “After the rate spikes for the Presidential funeral and year-end, it is clear that normal liquidity events can easily send overnight rates soaring.”
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