Optional: Listen Instead of Reading
Earlier this week, The Federal Reserve did something unusual something they haven’t done since the global financial crisis, they stepped in to keep the effective fund’s rate below the Fed range of 2 to 2.25%. So, the question is why is it so important. For one the Repo or (repurchase or reverse repurchase agreement) is a way that large institutions such as banks and hedge funds buys a bond and then borrows the underlying asset. Many institutions use this method to finance the purchases of US Treasuries, Mortgage-Backed Securities, and other low-risk assets. On average hundreds of Billions of Repos are traded daily. On Monday morning the Repo rate soared up to 7%, which unexpectedly raised the financing cost for many asset owners, as shown on the graph below.
So, what caused this sudden spike that the Fed needed to implement emergency actions, it could be attributed to a variety of influences such cash reserves in the banking system out of balance with the volume of securities on a dealer balance sheets, corporate tax payment due; last week treasuries auctions and last week bond market selloff.
As indicated today the Federal Reserve announced conduct another overnight Repo operation of $75B to stabilize the markets which is an omen of things to come. If the Federal Reserve didn’t act this could cause repercussions broader economy such as raising the cost of borrowing from mortgage rates to car loans further damping GDP growth. The Federal Reserve may be looking in another round of QE (Quantitative Easing) which would drive up risk assets such as stocks to new highs, and lowering the interest rates to stimulate growth in the broader market. So while this maybe just anomaly history tends to tell us differently, while there is nothing in the forecast to indicate a recession for another 1 or 2 years this gyration in the bond markets can be indicating that a recession may be sooner than predicted.