What is Going On in the Fixed Income Repo Market?


Kevin Gale, Managing Director, Head of Fixed Income

By now, most investors have heard of the volatility that occurred in the repo market in September. What is the repo market? A repurchase agreement (or repo for short) is a form of short-term borrowing. It is the sale of a security, usually government related securities, for cash with a commitment to repurchase those securities at a predetermined price at a later date. The length of the repurchase agreement can vary, but overnight is the most common. The size of the repo market varies on a daily basis, but on average is $2 trillion per day.

Historically, the repo market has been a highly liquid, dependable and stable market for short-term borrowers. In September of 2019, cracks in the system surfaced as borrowing rates unexpectedly spiked. The underlying cause of this spike in rates has many factors, including significant issuance of short-term T-bills by the Treasury, corporate tax payments due in mid-September resulting in investors pulling billions of dollars of cash out of the market at once, scarcity of bank reserves and increased demand for financing.

The spike in rates in September has since been mitigated, in part with help from the Fed. The Fed conducted open market operations to help increase the supply of reserves and began to repurchase T-bills, injecting additional cash into the market. The Fed has now committed to purchase $60 billion of T-bills per month at least through the second quarter of 2020. Combined, these actions have helped stabilize the repo market for the time being.

Will these actions by the Fed prevent the unexpected spike in repo rates from happening again? We believe we could see additional volatility in the repo market going forward. The unintended consequences of increased regulations on banks has prevented them from their traditional role of stepping in to help calm the market, leaving nearly all the responsibility on the Fed to do this. In addition, as the U.S. (both the government and corporations) continue to increase their reliance on debt financing, the supply and demand imbalance for borrowing needs can quickly rise, leading to higher volatility in rates.

How does this impact your portfolio? Individual investors do not directly invest in the repo market. However, mutual funds such as money market funds and larger institutional investors participate in the repo market on a regular basis. From a credit perspective, we do not believe loss of principle is likely. We believe that any volatility in the repo market will be temporary and would create opportunities for short-term fixed income investors. Opportunities could arise by a sudden spike in short-term commercial paper rates and yields on ultra-short bonds unexpectedly spiking. We will continue to monitor the situation closely.

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