(Bloomberg) -- Rates in the US funding-market surged at the turn of the quarter in a sign that liquidity pressures are building in the plumbing that underlies the world’s biggest financial system.
Volatility intensified this week beyond the typical spikes seen at the ends of months and quarters, when banks shore up their balance sheets for regulatory purposes by reigning in activity in the market for repurchase agreements. That is fueling debate around how much longer the Federal Reserve can remove liquidity from the system via its quantitative tightening program — known as QT — without causing a crunch.
“Most of these developments have rather benign explanations,” John Velis, a foreign-exchange and macro strategist at BNY, wrote in a note to clients on Tuesday. “However, taken together, and in a context of continuing balance-sheet runoff by the Fed via its QT program, it does raise concern.”
The Secured Overnight Financing Rate — an important one-day lending benchmark linked to activity in the repurchase agreement market — rose to 4.96% as of Sept. 30, according to New York Fed data. Overnight general collateral repo traded as high as 5.90% on Monday and demand swelled for sponsored repo, a key source of liquidity for the money-market fund industry.
A representative for the New York Fed declined to comment.
The Fed has already taken steps to reduce potential strains in funding markets, such as slowing the pace of the balance-sheet runoff it began in June 2022. Bank reserves near $3.14 trillion are generally considered abundant.
Roberto Perli, who oversees the central bank’s portfolio of assets, said last week that officials are monitoring repo markets for “early warning signs of shifting reserve conditions” and other potential risks as the runoff continues.
Many on Wall Street, however, recall extreme funding-market volatility that occurred in September 2019, when a lot of cash flowed out of the repo market just as more securities were flowing in — meaning that suddenly there wasn’t enough cash for those who needed it.
This time, market participants are closely watching for clues on when precisely the Fed will cease QT, and whether it will end before liquidity pressure grow worrisome.
Here are a few of the key funding-market rates to monitor:
Secured Overnight Financing Rate
The uptick in SOFR on Sept. 30 pushed the spread between the benchmark and the effective fed funds rate, which policymakers this month cut by half a point, to 13 basis points — the most since March 2020. Excluding days when the Fed has raised interest rates, which results in a increase of the benchmark, it’s also the largest one-day increase in SOFR fixing since March 2020.
Barclays strategist Joseph Abate said early Tuesday trading suggests SOFR might have moved to 5.03% for Oct. 1.
Standing Repo Facility
The Fed’s Standing Repo Facility allows eligible institutions to borrow cash in exchange for Treasury and agency debt at a rate in line with the top of the Fed’s policy target range — currently a minimum of 5%. This is meant to help put a ceiling on repo rates, though there have been questions about whether it does so during moments of market stress.
On Monday, balances at the SRF rose to $2.6 billion, the highest level since before the daily operations were made permanent more than three years ago. Wrightson ICAP senior economist Lou Crandall referred to this as a “good-news/bad-news story,” acknowledging that while at least one or more counterparties were willing to go to the Fed, a relatively small amount was financed through the central bank when market rates were elevated.
Usage has normalized as Tuesday’s operation received no bids.
Sponsored Repo
Sponsored repo activity totaled $1.78 trillion as of Sept. 30, Depository Trust and Clearing Corp. data show. That surpassed the previous all-time high of $1.57 trillion reached on Sept. 27 as dealer constraints drove more activity to this part of the repo market.
Sponsored repo transactions allow lenders to transact with counterparties like money-market funds and hedge funds, without bumping up against regulatory constraints of their own balance sheets. These agreements are effectively “sponsored” or cleared via the Fixed Income Clearing Corp.’s repo platform, thereby allowing dealer-banks to net two sides of a trade and hold less capital against it.
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