The rates on overnight repurchase agreements, known as repos, suddenly rose above 9% last week. Repos are a common way banks and brokerage firms can borrow cash by pledging assets such as Treasury securities as collateral. In normal markets, repo rates track closely to the Fed Funds rate, which was about 2% at the time.

In response to this spike in overnight borrowing rates, the Federal Reserve used open market operations to inject more cash into the banking system. Most people think this disruption was an isolated or idiosyncratic event, but the last time the Fed conducted liquidity operations of this sort was during the financial crisis. Therefore, this week’s activity has caused some questions and concern. However, unlike in 2008, the banks appear to be in sound financial shape and there has been no accompanying widening of credit spreads to ring alarm bells.

The good news is the Fed stabilized repo rates and will to continue inject liquidity as needed. But, why did overnight funding rates jump up in the first place?  

While no one knows for sure, the funding stress is likely related to particularly large cash needs this past week. Corporations and individuals needed cash for tax payments at the same time that U.S. Treasury dealers needed to finance their Treasury auction positions. Further, since 2017, the Fed has followed a path of reducing excess liquidity in the financial system, and perhaps it’s tightened too much. Given the increased issuance of Treasury securities to fund increasing levels of US debt, it seems like more liquidity will be needed going forward.  

Fed Chairman Powell has stated they will take measures to prevent these kinds of disruptions in the future, including regular open market operations, offering longer term repos, and potentially increasing the size of the Fed’s balance sheet.