MT481 Unit 10 Repo Market Event Paper Example

282 Basis Points Overnight: An MT481 Unit 10 Market Event Paper on the September 2019 Repo Spike

[Student Name]

Purdue University Global

MT481: Financial Markets

Unit 10 Market Event Paper

[Instructor Name]

[Date]

The dealer example is illustrative; the market events, rates and sources cited are real.

Why This Event

The repurchase agreement market, where dealers and others borrow cash overnight against Treasury securities, is the plumbing of the financial system. On most days it is invisible: rates sit close to the Federal Reserve's administered rates and move a few basis points. In mid-September 2019 it broke briefly, and the episode shows how a market thought to be awash in cash could run short in a single day. The paper relies mainly on two accounts written soon afterward: a Federal Reserve Bank of New York staff report (Afonso et al., 2020) and a Bank for International Settlements review (Avalos et al., 2019).

The Timeline

Monday, September 16, 2019, brought two large cash drains at once. Quarterly corporate tax payments were due, moving cash from corporate and money fund accounts into the Treasury's account at the Fed. And about $54 billion of newly auctioned Treasury coupon securities settled, so buyers paid the Treasury for them. Both moved reserves out of the banking system and into the Treasury's account, where they could not be lent. That day the main overnight Treasury repo benchmark, SOFR, rose to 2.43 percent, already above its usual level.

Tuesday, September 17, was the central day. SOFR rose to 5.25 percent, 282 basis points above Monday. Some repo trades were reported near 10 percent during the morning. The effective federal funds rate reached 2.30 percent, above the 2.25 percent top of the Fed's target range and 20 basis points above the 2.10 percent rate the Fed paid on excess reserves. The New York Fed conducted its first overnight repo operation in more than a decade that morning, lending $53 billion against Treasury and agency collateral.

Wednesday, September 18, the Federal Open Market Committee cut its target range by a quarter point, as planned, and made a technical cut to the rate on excess reserves. The New York Fed continued daily repo operations, which calmed the market.

Friday, October 11, the Fed announced it would buy Treasury bills, about $60 billion a month at first, to rebuild reserves, and would continue repo operations into 2020.

What the Spike Cost

For a dealer that financed $1 billion of Treasury inventory overnight on September 17, the jump of about 282 basis points cost roughly $78,333 in extra interest for a single night, calculated on a 360-day year. Dealers financing far larger inventories faced costs in the millions, and some cut back their market-making in Treasuries that week.

Who Felt It

The spike reached well beyond dealers. Hedge funds that financed Treasury positions in repo paid far more overnight. Money market funds, the main cash lenders, earned unusually high returns for a day but faced questions about whether the market was functioning. Banks that borrowed in the federal funds market paid above the Fed's target range, which mattered most to the Fed itself, because the federal funds rate is the rate its policy targets. For a central bank whose credibility rests on keeping that rate inside the range it announces, a break above the range was a signal that its operating framework had a gap.

The Causal Chain

A causal chain diagram in the paper links four conditions that turned an ordinary tax day into a spike.

First, reserves had fallen. The Fed had been shrinking its balance sheet since 2017, letting securities mature without replacement, and the Treasury had built up its cash account at the Fed. Reserves had declined from about $2.8 trillion at their peak to around $1.4 trillion.

Second, the remaining reserves were concentrated at a few large banks, which were not willing to lend them freely. Those banks kept large reserve balances to meet their own intraday payment needs and regulatory liquidity requirements, and their internal rules made them reluctant to lend reserves overnight even at attractive rates.

The system had plenty of reserves on paper, but the banks holding them would not lend them that morning.

Third, dealers held heavy Treasury inventories after a period of large Treasury issuance, and needed to finance them in repo.

Fourth, the two cash drains of September 16 fell on the same day.

Avalos et al. (2019) emphasized the role of the four largest banks, which had become the marginal lenders in repo and stepped back that day. Afonso et al. (2020) documented the timing and the stress across funding markets. Copeland et al. (2021) later argued that reserves were not as ample as policymakers had believed, because the demand for reserves by large banks was higher than estimated.

The Response and the Lasting Change

The Fed's immediate response was to supply cash through repo operations, and its longer response was to rebuild reserves with bill purchases. The lasting institutional change came in July 2021, when the Fed established a Standing Repo Facility, offering to lend cash daily against Treasury and agency securities at a set rate. The facility acts as a ceiling on repo rates, so that a shortage of private lending cannot push them far above the Fed's target range again. Mishkin (2019) describes how central banks use lending facilities as backstops, and the standing facility makes that backstop permanent for the repo market.

What the Event Teaches

The September 2019 spike shows that liquidity depends on distribution as well as quantity. A system with $1.4 trillion of reserves could still run short if the banks holding them would not lend, and a predictable cash drain could tip it into stress. It also shows how quickly the Fed now acts to keep its policy rate within its range, and how a short episode can produce a permanent change in market structure.

A Lesson for Corporate Treasurers

For a company treasurer, the episode carries a practical warning. Funding that rolls overnight depends on markets that can seize briefly even when the system as a whole has plenty of cash. A company relying on daily repo or very short commercial paper should keep committed backup lines and avoid scheduling large cash needs on known drain days, such as tax dates and Treasury settlement days.

Limits

Accounts of intraday repo rates near 10 percent come from trade reports rather than a complete record, and the relative weight of each cause remains debated among the sources cited.

References

Afonso, G., Cipriani, M., Copeland, A., Kovner, A., La Spada, G., & Martin, A. (2020). The market events of mid-September 2019 (Staff Report No. 918). Federal Reserve Bank of New York.

Avalos, F., Ehlers, T., & Eren, E. (2019). September stress in dollar repo markets: Passing or structural? BIS Quarterly Review, December, 12-14.

Copeland, A., Duffie, D., & Yang, Y. (2021). Reserves were not so ample after all (Staff Report No. 974). Federal Reserve Bank of New York.

Mishkin, F. S. (2019). The economics of money, banking, and financial markets (12th ed.). Pearson.