September 2019 events in the U.S. repo market

Overnight lending Banks and financial institutions analyze their cash reserves on a daily basis, and assess whether they have an excess or a deficit of cash with respect to their needs. Banks that do not have sufficient cash to meet their liquidity needs borrow it from banks and money market funds with excess cash. This type of lending generally takes place overnight, which means that the cash is repaid the next day. The repo market Repurchase agreements, commonly referred to as repos, are a type of loans that are collateralized by securities and are generally provided for a short period of time. Although repos are economically equivalent to secured loans, they are legally structured as a sale and subsequent repurchase of securities. There are two steps in a repo transaction. First, the borrower sells their securities to the lender and receives cash in exchange. Second, the borrower repurchases the securities from the lender by repaying the cash amount they received plus an additional amount, which is the interest. In this context, the repurchased securities are most often Treasury securities, The daily volume of repo transactions is generally estimated to be around $1 trillion; hence, according to economists at the Bank for International Settlements, "any sustained disruption in this market[...] could quickly ripple through the financial system". The U.S. repo market is broadly divided into two segments: the tri-party market and the bilateral market. The tri-party market involves large, high-quality dealers borrowing cash from money market funds. This segment is called "tri-party" because a third party, the bank BNY Mellon, provides various services to market participants. The bilateral market involves large dealers lending to borrowers, such as smaller dealers and hedge funds. A common practice is for dealers to borrow cash on the tri-party market to lend it to their clients on the bilateral market. The federal funds market in Washington, D.C., which serves as the Federal Reserve System's headquarters. Federal funds are funds that are loaned or borrowed by financial institutions overnight to meet their liquidity needs. Unlike repos, federal funds are unsecured. According to economist Frederic Mishkin and finance professor Stanley Eakins, the term "federal funds" is misleading: "federal funds have nothing to do with the federal government", and term comes from the fact that these funds are held at the Federal Reserve bank". The repo market and the federal funds market are theoretically separate. However, there are significant links and interactions between the two, and shocks in one market can transmit themselves to the other. The interest rate on federal funds is an important component of U.S. monetary policy. == Events ==

Rates increase Before September 2019, both the SOFR and the EFFR were quite stable. The EFFR had remained within the FOMC's target range on all but one day since 2015. The SOFR was slightly more volatile, especially around quarter-end reporting dates, but had rarely moved more than 0.2 percentage points on a single day. On Monday, September 16, the SOFR was at 2.43 percent, an increase of 0.13 percentage points compared to the previous business day (Friday, September 13). The EFFR was at 2.25 percent, an increase of 0.11 percentage points from September 13. The EFFR was trading at the upper limit of the Federal Reserve's target range, which was 2 to 2.25 percent. On the morning of Tuesday, September 17, interest rates on overnight repo transactions experienced a sudden and unexpected increase. During the trading day, interest rates on overnight repo transactions went as high as 10 percent, with the top 1 percent of transactions reaching 9 percent. The SOFR benchmark increased by 2.3 percentage points and reached 5.25 percent for the day. and the rates on federal reserve funds decreased to 1.9 percent. Aftermath The New York Fed continued to offer liquidity to market participants for several months, in an effort to control and limit volatility. In June 2020, the New York Fed tightened its operations on the repo market, after seeing "substantial improvement" in market condition. From June 2020, market participants stopped using the Fed's liquidity facility. == Suggested causes ==

The cause of September 2019 market events was not immediately clear, By contrast, the government can decrease reserves by selling government bonds, such as Treasury securities, to investors, which results in cash being transferred from bank accounts (and thus reserves) to government accounts. In mid-September 2019, the supply of reserves in the banking system amounted to $1.4trillion, their lowest point since 2011. Economists and analysts have suggested that such a low amount of reserves may have exacerbated the liquidity shortage experienced on September 17. Liquidity regulations require banks to hold a stock of liquid assets (such as cash) at all times to survive crisis scenarios, such as bank runs. Some economists have acknowledged that liquidity regulations may have prevented banks from lending more cash on the repo markets in September 2019, thus contributing to the cash shortage. Other researchers have taken a different view. They have argued that the inability of banks to deploy liquidity quickly to profit from the high rates was not caused by the liquidity regulations themselves, but by the more prudent risk-management framework put in place by banks after the 2007-08 crisis. They have also pointed out that other significant lenders on the repo market, such as money market funds and pension funds, were similarly reluctant to lend in mid-September 2019, despite not being subject to banking regulations. Other suggested causes Economists and market observers have suggested other factors as possible causes of the mid-September spike: • the inelasticity of the demand for funding in the tri-party segment of the repo market, such that "even small changes in the supply and demand for cash could result in large interest rate increases", according to economists at the New York Fed • The surprise caused by the sudden increase in interest rates on the morning of September 17, which may have led lenders to halt their lending until they could gather more information about the market conditions • A general decrease in the amount of repo lending by money market funds beginning in August 2019, caused by a shift of the funds' portfolios to Treasury securities, which were expected to provide higher returns • The increasing complexity of cash management at multinational U.S. banks == See also ==

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