The Daily Update: The Fed and the Repo market

The US Treasury market (UST) is the mainstay of global finance providing funding for the government, a safe haven for investors and a benchmark for interest rates globally. However, over recent times the market has not behaved as seamlessly as the authorities would want, hence the FED’s new Repo facilities we discussed on Thursday last week. We have been asked to explain more of the workings and so here we go.

A great number of investors use the Repo market to raise short term loans from securities dealers who, the majority, are owned by the large banks. That is, they use their US Treasury holdings as collateral against the said loans. Now what has happened is that the supply of UST has vastly outgrown the amount of loans available and so from time to time this appears as a stress in the market pushing the rate of the loans up. This was clearly seen last year during the first quarter as the pandemic hit, repo rates shot up, the Fed had to step into the market with trillions of dollars in emergency liquidity.

So the Fed announced their new facilities the Standing Repo Facility with a balance of $500bln which is available to a select group of Primary dealers in the States and a further Foreign and International Monetary Authorities repo facility which is available to foreign central banks to the tune of $60bln per counterparty.

In this way the Fed are adding liquidity to the market on an ongoing basis and should help alleviate the short fall in loans available through the Repo market.

We expect further measures from the Fed such as adjusting the amount of capital banks need to hold against total assets. Here too the banks are often holding cash as a risk-free asset on their balance sheets and not using that cash to loan out against UST in the repo market, again not helping the normal functions of the market. Also, we would not be surprised if the Fed suddenly widened the availability of the recent facility from primary dealers, generally owned by the banks, to a broader range of investors, again easing any pressures from a lack of liquidity available for UST repos.