JP Morgan on Year-End Repo Spike
J.P. Morgan's latest "Short-Term Fixed Income" update, entitled, "What happened to repo at year-end?" tells us, "While it's common to see repo rates spike around year ends as dealer balance sheets shrink, the repo markets experienced an extra dose of volatility this year. On 12/31, overnight GCF Treasury repo rates surged to an all-time high of 5.149%, increasing by 260bp from the day prior. Relative to previous year ends, this is the single biggest one-day jump in overnight GCF repo rates by far.... A similar, but smaller, spike occurred in the tri-party repo and GC repo market as well, and because these transactions are components of SOFR, SOFR also increased by 54bp to 3.00%. In part, regulations contributed to what transpired as they tend to dampen overall market activity at key moments, like year-end. In particular, the calculation of G-SIB surcharges is based on year-end score snapshots which incentivizes US systemically important banks to temporarily reduce their balance sheet intensive activities like repo. This is especially true for those that are close to entering into the next higher G-SIB surcharge bucket or moving down into the next lower G-SIB surcharge bucket.... As a consequence, borrowers often find themselves paying up for funding during a time when there is already little liquidity and ultimately bearing the costs of banks trying to manage/optimize their balance sheets for regulatory purposes." The update explains, "With all that said, the repo markets have normalized since year-end. As of COB Friday, overnight GC repo rates have settled around 2.80%, much lower than where they were at year-end. Reflecting on this, the events of the past few days reminded us that for as liquid as the repo market is relative to Libor, there are also vagaries in the repo market that make SOFR a much more volatile benchmark day to day. In this instance, regulations seem to have played a large role in reducing liquidity at a time when market depth is already expected to fall as trading desks thin out for the holidays.... Tack on the current environment where dealers are heavy with collateral and banks are on their way to reducing their excess reserve balances (not so much because of Fed normalization but more because they're rotating into other higher yielding asset classes), repo rates and consequently SOFR will likely only become more volatile in the near future. While developments like sponsored repo and the newly issued Basel proposal to report banks' total leverage exposure measure on a daily average basis will help temper this volatility, it's unclear to what degree.... Until then, we wouldn't be surprised if we see more volatility in repo rates, especially around quarter-ends or on days when there is less liquidity generally (e.g., the national day of mourning of former US President George H.W. Bush) as the markets adjust to shifts in financing availability on those days." JPM adds, "Even so, it's worth mentioning that the dislocations we've seen in repo rates recently are not reflective of funding stress in the fixed income markets such as the one in 2008. As we discussed in our 2019 Outlook, over the past few years the repo market has grown larger, broader, and deeper. Usage at the Federal Reserve's RRP facility has greatly declined and innovative uses of sponsored repo have provided both lenders and borrowers new opportunities. Overall, there has been more financing in the repo markets, even if there are temporary spikes in repo rates."
