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Marc Cuniberti: REPO market says everything is fine

 

An interesting development has been occurring in the Federal Repurchase Agreement Operation (REPO).

The REPO market is administered by the Federal Open Market Committee (FOMC) and when they act, it is called Open Market Operations.

The REPO market is a Federal facility that moves cash in and out of the banking system on a daily basis to satisfy liquidity requirements. When financial institutions (like banks and money market funds) need day-to-day cash, they can borrow money from the facility. They then deposit U.S. Treasury IOU’s (called Treasuries) into the facility as collateral. This transaction is called a “REPO” transaction.



Conversely, they can instead deposit cash into the facility and in return take Treasuries back. This is called a “Reverse REPO” transaction.

The financial intuitions that are authorized to use the facility keep a stock of Treasuries and cash on hand to facilitate the transactions between them and the FED.




Think of the REPO facility as a huge octopus handing money out and taking money in daily. The financial institutions use this facility to fund their day-to-day operations. The FEDS also use the facility to inject more cash into the system when the economy slows, or take money out of the economy when it overheats. It is sort of a two-way street that helps the financial institutions control their cash flow while helping the FED gas the economy (stimulate it) or put the brakes on (slow the economy down).

Gassing the economy might occur at a time when the economy is ailing (like during COVID-19 or 2008/09) and braking might be needed if inflation takes off.

When the financial institutions park excess cash at the facility (Reverse REPO) they earn little to no interest (at the FEDS discretion) but it’s a safe place to park as much cash as they desire. Keep in mind the facility is very short term and frequently described as an overnight conduit for cash. When the financial institutions need funds and therefore are borrowing cash, they use the Treasuries they own as collateral. They then pay interest on the cash they borrow called the “REPO rate.”

The FED can also increase the interest (the REPO rate) to discourage borrowing and slow the economy, or if they lower the borrowing rate, it makes money cheaper to the financial institutions and speeds the economy up as it encourages the financial institutions to loan that cash out to consumers and the like.

During 2008/09, and early on during the COVID-19 pandemic, and during other times when the economy or markets faltered, there was more money borrowed than deposited, as the users needed money to weather the downturns.

During these high withdrawal periods, the FEDS have had to pour billions and billions of new monies into the REPO market to satisfy the cash needed. In 2008/09, they also extended what type of collateral they would accept to include mortgage and bond type products. Many said this relaxation of collateral requirements went beyond the FEDS REPO market operational mandate, but that’s a story for another day.

Usually the REPO market operates in some sort of balance, meaning it requires no new money or interference from the FED. If the REPO facility does require assistance, it’s usually because there is a shortage of cash and they have to add more. Rarely does the ebb and flow go the other way, meaning those authorized to use the FED seldom deposit cash into the FED for very long. In essence, the banks usually always need money, and seldom have an excess of it.

Not so in recent weeks. Financial institutions seem flush with cash and have parked close to half a trillion at the FED and more is coming in every day. A change from just a few short months ago, the REPO market is seeing the rare event of too much cash.

Theories abound as to why these money institutions have so much cash right now. They range from FED stimulus programs to consumers apparently going on spending sprees or just the mountain of cash that has been dumped into the financial system by the FED for whatever reason. Either that or the supply of IOU’s from the FED (those U.S. Treasuries again) is in short supply.

Whatever the reason, the REPO market is a bell weather for stress in the financial system, and right now it’s saying there is a lot of money floating around and therefore the banking system may be doing just fine.

Marc Cuniberti holds a B.A in Economics with honor from San Diego State University and is the hose of Money Matters carried on 66 stations nationwide. California Insurance LIc# 0L34249. Call him at 530-559-1214 or visit http://www.moneymanagementradio.com


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