What Is The Repo Market?

People know to talk about repo, but don’t actually know what it is about. What is repo? Why does it matter?

Why Is Reverse Repo Use So High? Focus On Collateral! 1

The Repo market is the largest market that people do not know exists

Skyrocketing use of the Fed’s Overnight (o/n) Reverse Repurchase Facility is more of an issue with collateral scarcity rather than bank reserves.

This comes down to US Treasuries’ status (especially T Bills) as the repo market’s preferred form of collateral. Which also means that changes in levels of demand for USTs will tell us if there really is an ongoing collateral shortage.

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Why Is Reverse Repo Use So High? Focus On Collateral! 2

The Repo market is the largest market that people do not know exists

Interestingly, Low Yields in 5 year Note auctions have dived lower over the last few months, following the same pattern as those set by the Bills (but not the 2 year Note).

While High and Median Yields have not fallen by much, Low Yields are lower by approximately 60 basis points since March.

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A Simple 0.05% Increase Caused A $235 Billion Tsunami. Why?

The Repo market is the largest market that people do not know exists

The Fed raised the rate it pays on its Overnight Reverse Repo Facility from 0% to 0.05% at the end of its latest policy meeting, held last week.

While 5 basis points sounds miniscule, they’ve already created a $235 billion tsunami.

What are the implications?

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The Fed’s New Repo Misdiagnosis. The SRF Won’t Work 1

Fed misdiagnoses problems in the repo market

The Fed has announced that it will establish two new repo facilities, one domestic Standing Repo Facility (SRF), and the other international.

The purpose of which is to ensure that funding markets have ready access to cash during times of acute market stress. While this is a positive step, in the sense that the Fed is actively trying to pre-empt future market meltdowns, it is unfortunately one that will not work.

Here’s why.

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The Fed’s New Repo Misdiagnosis. The SRF Won’t Work 2

Fed misdiagnoses problems in the repo market

While the Fed has misdiagnosed the collateral issues plaguing the repo market, it is important to understand that its new Standing Repo Facility (SRF) can alleviate some pressure in the financial system during times of crisis.

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