The news media, bank executives, the U.S. Federal Reserve (the Fed) chairman and even presidential candidates have made remarks about the recent spike in short-term funding rates. What caused the spike, and why is it important?
In mid-September, there was a significant spike in the overnight repurchase agreement (repo) rate. The repo rate reflects the level where lenders (e.g., institutional investors and banks) will extend collateralized cash loans to borrowers (e.g., broker-dealers and other market participants) to meet short-term funding needs. The repo market is like the oil that keeps the financial engine running by supplying liquidity through overnight collateralized loans between market participants.
The spike in rates caught many by surprise, despite warnings by the dealer community over declining bank reserves. The consensus view is that a combination of low bank reserves, corporate tax payments and the settlement of the monthly U.S. Treasury auction caused a temporary shortage of cash in the system, forcing repo rates higher.
Timeline and Fed response
- On Monday, September 16, and continuing through Tuesday, September 17, overnight repo rates, which had been trading around 2.25%, climbed to over 8.5%.
- On Tuesday morning, the New York Fed announced it was adding over $50 billion via overnight repurchase agreements in order to stabilize repo rates. This was the Fed's first significant use of the temporary repo facility since the Global Financial Crisis (GFC).
- On both Wednesday and Thursday (September 18-19), the Fed injected an additional $75 billion into the market through new overnight repo operations. These actions largely produced their intended effect with repo rates declining to around 4% by Wednesday morning, September 18.
- On Friday, September 20, the New York Fed announced a series of ongoing overnight and term repo operations through October 10, intended to boost short-term liquidity.
- On October 4, the Fed announced it
