NEGATIVE Repo Rates can happen when there is a shortage of cash or particular collateral security, like negative-yielding bonds, are put up to borrow against. Therefore, trying to borrow against a negative-yielding bond can present a crisis. The standard Repo contracts, such as the Global Master Repurchase Agreement (GMRA), have been drafted under the implicit assumption that general collateral (GC) Repo Rates would only ever be positive—Martin Armstrong
The US Federal Reserve Has Lost Control: As Repo Rates Skyrocket, Rumblings in US Money Markets Reverberate Across the World!
From Yahoo/AFP: (September 20) The New York Federal Reserve Bank said Friday it will inject billions into the US financial plumbing on a daily basis for the next three weeks in an effort to prevent a spike in short-term interest rates. The Fed will offer up to $75 billion a day in repurchase agreements -- exchanging secure assets for cash for very short periods -- through October 10, it said in a statement. In addition, it will offer three 14-day "repo" operations of at least $30 billion each. Banks have struggled in recent days to find the cash needed to meet reserve requirements which has pushed up short-term borrowing rates, prompting the New York Fed to pump billions into US money markets with repo operations over the past four days. However, in a sign a cash crunch could be easing, demand for liquidity on Friday did not significantly exceed the amount offered, as it had on two prior days. After October 10, the New York Fed will "conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined." [bold mine]
The US Federal Reserve has been forced to respond to magnified signs of instability in the money markets as evidenced by rocketing of Repo Rates that has caused considerable dislocations on the Fed’s floor monetary system.
Operating under an ample reserves framework, by establishing a “floor” or a limit at which bank lending of reserves with other counterparties, the rate of interest rate on excess reserve (IOER) supposedly influences the Fed Fund rates as “No bank would lend reserves to another bank at a rate less than the rate it could receive by simply keeping cash parked at the Fed”. (Ng and Wessel, May Brookings 2019)
And because of repurchase agreements involve the participation of nonbanks, the overnight-reverse-repurchase agreement rate (ON RRP), one of the three rates in the Fed’s monetary stance supposedly sets a floor on market repo rates. (Money and Banking June 2019)
By the way, repos or repurchase agreement (repo), as defined by the Investopedia represents “a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the party on the other end of the transaction, buying the security and agreeing to sell in the future, it is a reverse repurchase agreement.”
But theory and reality has gone asunder.
As free banking wizard George Selgin presciently observed, “If market rates don't keep step with the IOER rate, monetary policy isn't working properly. And if they don't budge when the IOER rate changes, monetary policy isn't working at all…”
Figure 1
The gap between the Effective Fed Fund (EFF) rates and IOER widened to 2009 levels. Negative spreads between the EFF and IOER emerged as far back in late March of this year. ON RRP rocketed past 2008 and 2001 recession levels last week. ON RRP has been ascendant since 2016! (see figure 1)
The consensus have dismissed and rationalized these to the “$35 billion money market outflows to fund September 15th quarterly corporate tax payments; settlements for outsized Treasury auctions; and the approaching end to the quarter (where money center banks generally reduce balance sheet leverage for financial reporting and regulatory purposes)”, however as some astute pundits have been pointing out, the scramble for short term liquidity didn’t happen overnight; it had been building through time intensifying as it ages.
Should such money market turmoil be ignored in the face of today’s uncharted environment where USD-CNY has broken the 7-threshold, sovereign bonds with negative yields which recently hit a $17 trillion as bond yields etched record low around the world, inverted yield curves gripped advanced economies, systemic leverage running at uncharted levels, global central bank in a rush to slash rates*, US financial assets at a historic 5.6x GDP, and others…?
Figure 2
*As a side note, rate cuts were announced by the US Federal Reserve (2nd for the year), Bank Indonesia (3rd time), Peoples’ Bank of China (2nd cut on loan rate), and Hong Kong Monetary Authority (2nd) this week. In contrast to the general trend, Norway’s Norges Bank increased its policy rate for the fourth time in 2019. (figure 2)
Should these just be considered coincidences? It can’t be. The perspicacious Doug Noland of the Credit Bubble Bulletin explicates: (bold added)
It is surely No Coincidence that this week’s “repo” ructions followed last week’s spike in yields and resulting deleveraging. Is it a Coincidence that the marketplace experienced a powerful “rotation” that saw the favorite stocks and sectors dramatically underperform the least favored? Is it a Coincidence that hedge fund long/short strategies have been clobbered, in what evolved into a powerful short squeeze and dislocation? Surely, it’s No Coincidence the so-called “quant quake” foresaw this week’s quake in the repo market.
Let’s expand this inquiry. Is it a Coincidence that this week’s money market upheaval followed by a few months dislocation in the Chinese money market? And is it mere Coincidence that U.S. money market instability erupted on the heels of the ECB’s decision to restart QE?
There are No Coincidences. Chinese money market issues and currency weakness were fundamental to the global yield collapse. Trade war escalation risked pushing China’s vulnerable Credit system and economy over the edge. Global central bankers responded to sinking bond yields with dovish talk and monetary stimulus, feeding the unfolding bond market dislocation. Collapsing market yields and dovish central banks stoked melt-up dynamics in stocks and sectors seen benefiting from a lower rate environment. Growth stocks were caught up in speculative melt-up dynamics, while short positions in underperforming financials and small caps were popular hedging targets. Both momentum longs and shorts became Crowded Trades
The world doesn’t operate in a vacuum. And actions have intertemporal consequences.
Figure 3
And why have primary dealers been hoarding USTs and why the accelerated stashing of these in 2019? (figure 3)
The brilliant exponent of the Eurodollar, Mr. Jeffrey P. Snider from Alhambra Partners explains: (bold mine)
How do we know which is which? Very, very easy. Every single price and yield up and down the curve says there is and has been overwhelming demand in the financial public for UST’s. So much so, people and financial entities are willing to pay premiums on them, to gain less in yield for UST’s than they would through other financial alternatives (such as the Fed’s reverse repo; why are T-bills yielding less than the RRP if there isn’t excessive demand for T-bills?)
If you are in the camp of dealers stuck with UST’s, then special factors. If you instead look at actual price evidence and apply basic common sense, dealers purposefully hoarding UST’s, unwilling to part with them apparently at any price, then you appreciate the significance of building systemic pressures which is instead more and more exposed by what are normal calendar bottlenecks no one would ever otherwise notice. The problem is therefore so much bigger than the fiscal US government deficit. Systemic monetary problem.
At the same time, DTCC’s agency fails have been climbing since June 2019. (figure 3 middle window) Collateral settlement fails, according to the DTCC, could be anchored from miscommunication, constrained technology, insufficient collateral, and counterparty insolvency.
When aggregate “fails” on a particular security balloon, it is likely a symptom of the scaling of bottlenecks and shortages of collateral settlements. And when reinforced by counterparty problems, the issue becomes systemic.
And now we proceed to the relationship between repo rates and swaps.
From Bloomberg Yahoo (September 20): Meanwhile, the costs of borrowing dollars in funding markets is still elevated. In currency swap markets, handing over yen in return for dollars for one week -- a time period which covers the crucial month end -- now costs you the equivalent of 2.4% on an annualized basis. It was just 0.2% a week ago. The same is true in cross-currency basis -- where banks and financial institutions can swap floating-rate payments in different currencies -- with the premium for the Australian dollar over its U.S. counterpart collapsing by the most in eight years during Asian trading hours on Friday. Finally, the spread between U.S. Treasuries and interest rate swaps reached a record low Wednesday. That’s an indication that traders are getting anxious about the rate at which they can finance bonds, and are starting to use swaps instead. [bold mine]
In other words, the US dollar scarcity has been spreading across the US financial markets, and subsequently, around the world.
Back to Mr. Snider: And so, ultimately, if dealers aren’t willing to sell UST’s, and that’s what all the evidence says, why would they be hoarding them like this? Not because they fear a breakdown in fed funds, the Fed being backward about everything, but because they recognize the non-trivial risks of a breakdown in repo – which is merely confirmed by the increasingly abnormal behavior in fed funds as in other more relevant and important markets like swaps.
The mainstream has advocated several fixes to the current bout of money market tremblor led by the re-imposition of LSAP or Quantitative Easing (QE) and or the Standing Repo Facility (SRF) among others.
Good luck with that.
