Will the U.S. repo market crisis repeat itself in the spring?

Dark clouds are threatening to destroy the city, mountains and rain are about to come, and the wind is filling the buildings.

According to official data from the New York Fed, on January 12, 2024, the balance of funds in the Federal Reserve’s overnight reverse repurchase (ON RRP) fund pool has dropped to $600 billion. This is down by two-thirds from the relative high of 2.4 trillion in March last year (2023).

As introduced in the 2023.12.10 Liu Jiaolian article "The "Truth" of the Federal Reserve" and the 2023.10.4 article "The Federal Reserve's Layoffs of the Century", the Fed's method of controlling market interest rates is mainly through overnight repurchases and reverse repos. these two tools.

For example, we can usually see three paragraphs like this in the executive minutes of the Federal Reserve’s latest interest rate meeting (FOMC):

* Undertake open market operations as necessary to maintain the federal funds rate in a target range of 4-1/4 to 4-1/2 percent.

* Conduct overnight repurchase agreement operations with a minimum bid rate of 4.5 percent and with an aggregate operation limit of $500 billion; the aggregate operation limit can be temporarily increased at the discretion of the Chair.

* Conduct overnight reverse repurchase agreement operations at an offering rate of 4.3 percent and with a per-counterparty limit of $160 billion per day; the per-counterparty limit can be temporarily increased at the discretion of the Chair.

The translation is:

* Take necessary disclosures Market operations maintain the federal funds rate within the target range of 4-1/4 to 4-1/2 percent.

* Conduct overnight repurchase agreement operations with a minimum bid rate of 4.5% and a total operating limit of US$500 billion; the total operating limit can be temporarily increased at the chairman's discretion.

* Conduct overnight reverse repurchase agreement operations with a bid rate of 4.3% and a daily limit of US$160 billion for each party; The limit may be temporarily increased at the discretion of the Chairman.

Financial jargon can easily confuse the mind. The "repurchase" and "reverse repurchase" here are based on "U.S. debt" and are expressed from the standpoint of the Federal Reserve:

The so-called " "Repurchase" means that the Federal Reserve prints dollars and buys U.S. debt back from banks, so it is called "repo" - buying back. Of course, they sell it the next day - in fact, the bank buys back the U.S. debt from the Federal Reserve. So this is called the overnight market.

Obviously, the purpose of "repurchase" is to provide temporary relief to banks. How thirsty do you think this bank must be? Without water this night, I would die of thirst.

Then please answer: Who pays interest to whom for overnight repurchase transactions? For example, the repo rate in December is 4.5%. Who pays whom?

Think about it first. Let’s move on to reverse repurchase.

The so-called "reverse repurchase" is naturally a reverse operation: the bank has too much money and it is too hot to let go, so it takes it to the Federal Reserve and buys it all into U.S. dollars. debt. From the Fed's perspective, it is selling U.S. bonds and withdrawing U.S. dollars. It is equivalent to collecting water. Of course, the U.S. debt will be bought back the next day and the water will be released again. It is also an overnight market.

Then the same question: Who pays interest to whom in reverse repurchase?

The "buy" and "sell" above do not mean buying or selling, but borrowing money. The answer is easy and very intuitive: whoever gets the money (dollars) pays the interest. That is, whoever borrows money pays interest.

So, repurchase is when the bank borrows money from the Federal Reserve, and the bank pays interest (4.5%) to the Federal Reserve; reverse repurchase is when the Federal Reserve borrows money from the bank, The Fed pays interest (4.3%) to banks.

The same goes for the other way around: Repo is when the Fed lends money to banks and charges interest (4.5%) to the banks; reverse repo is when the Fed borrows money from banks , pay interest to the bank (4.3%).

So, we understand that repurchase is equivalent to a loan product provided by the Federal Reserve to banks with a capital cost cap (4.5%), while reverse repurchase is It is equivalent to a financial product provided by the Federal Reserve to banks with a guaranteed return (4.3%).

If we look back at the U.S. dollar liquidity chart in the reverse repurchase reservoir above this article, we will have a big question: From 2021 From the middle of the year, to the middle of 2022, in one year, 2.5 trillion U.S. dollars, why did such a huge amount of funds flow into this reverse repurchase reservoir?

The answer to this question may have already been written in the 2023.8.21 article "Artificial Prosperity: The Great Transfer of Wealth" on Jiaolian.

What can be guessed is that this part of the money is not money that banks can easily misappropriate, and there is no better investment outlet in the market, so it is in the Federal Reserve This financial product with a risk-free guaranteed return of 4.3% is available.

Starting from the beginning of 2023, the amount of funds in this reservoir began to decrease, which showed the outflow of funds to other places. This corresponds to the rise of some stock markets and the rise of Bitcoin. This journey lasts for a year.

If it continues to decline at this rate, the remaining more than 60 billion U.S. dollars will be exhausted in about 3 to 4 months.

Around the turn of spring and summer.

It happens to be around the time of Bitcoin halving.

The market is betting on when the Federal Reserve starts the process of cutting interest rates.

When the reverse repo reservoir runs out of water, banks will rush to borrow money because they are extremely thirsty, triggering a crisis in the repo market. ?

On September 17, 2019, the overnight repurchase agreement interest rate for short-term loans between financial institutions suddenly blew out. The guaranteed overnight financing rate in the United States, which measures the overnight repurchase rate, was only 2.43% on September 16. It soared to 5.25% on September 17, and the interest rate on the trading day once climbed to 10%. Rates on unsecured loans between financial institutions have also been affected, with the effective federal funds rate, a measure of such rates, exceeding the Fed's target range.

The Federal Reserve Bank of New York intervened urgently and injected $75 billion in liquidity into the repo market on September 17. Since then, it has invested $75 billion every morning until the weekend. The Federal Open Market Committee of the Federal Reserve lowered the bank reserve interest rate on September 19. Combined with the measures taken by the New York Federal Reserve Bank, the market finally returned to stability, and interest rates returned to stability on September 20. Since then, the New York Federal Reserve has continued to regularly inject liquidity into the repo market until June 2020.

Although the cause of the crisis has not yet been determined, some economists believe that September 16 is the deadline for paying quarterly corporate taxes, and the United States has newly issued Treasury bonds, which together led to a temporary shortage of cash in the financial system, aggravated by the decline in reserves in the banking system, together led to a sharp rise in interest rates. [wikipedia]

Jiao Lian flipped through the calendar for Federal Reserve meetings. September 17, 2019, happened to be the first day of the Federal Reserve’s September interest rate meeting that year. The time when this crisis broke out was really a coincidence. The coincidence seemed to mean "I will die for you" in capital letters.

The interest rate range set at the previous interest rate meeting in July was 2%-2.25%. After such a commotion in September, the Federal Reserve obediently took advantage of the situation and lowered the interest rate range to 1.75%-2%.

At this point, I can’t help but think of the scene of rural aunts banging washbasins and making trouble at the door of the village government, and the scene of Wall Street making a fuss about the Federal Reserve. , no different from each other. I feel happy in my heart.

Just six months later, at the beginning of 2020, the famous meltdown occurred and the economy fell into recession. (Reference: "Talk about the history and future of Bitcoin in the context of the new crown epidemic and the US stock market meltdown" from the April 4, 2020 Jiaolian audio lecture)

Time flies. It has been 4 years in the blink of an eye.

On January 11, 2024, Redburn Atlantic chief economist Melissa Davies publicly pointed out that at the current high base interest rate level of 5.25%-5.5%, as well as the US dollar QT In the context of a tightening cycle, if insufficient bank reserves lead to liquidity problems, the repurchase crisis in 2019 may be repeated, which will force the Federal Reserve to stop QT quantitative tightening; in particular, when the Federal Reserve's ONRRP overnight reverse repurchase funds dry up, hedge funds They will face basis trading losses, this time forcing them to sell U.S. Treasuries, triggering a liquidity run.

I wonder if this time, will Fed Chairman Powell learn from the lesson and take action in advance to nip problems in the bud?