Not Transitory - Fed Liquidity Handout Surges To Near $90 Billion

So much for the 'transitory' liquidity shortage arguments put forth by commission-takers and asset-gatherers, The NYFed accepted $87.7 billion (in o/n and term) repo today - the highest level yet.

The Fed accepted $20.1 billion in 14-day term repo...

And $67.7 billion in overnight repo...

The biggest overnight repo (liquidity bailout) since September.

Having stabilized in the $30-40 billion range, liquidity needs have surged once again as it seems the big banks just cannot wait for The Fed's NotQE in November.

As Curvature Securities' Scott E.D. Skyrm, one of the world's most-respected repo market participants and experts, noted last week

We’ve seen the old pictures or films of people lining up outside of a bank to collect their deposits. Think of the Depression in the 1930s. Knowing that a bank can’t make good on all of their customers’ deposits means the first people to get their money are more likely to get their money. Period. Banks never keep all of their customers’ deposits as cash on hand. They invest those customers’ deposits by making loans - like a mortgage loan to a family to buy a home or loan to a business to help start a new venture. Banks invest in loans and borrow money through deposits. That also means they loan long-term and borrow short-term. Don’t worry, this is important later on.

Though banks still have the same problem today - lending long-term and borrowing short-term, increased regulation and stronger risk management has forced them to narrow the tenure mismatch. These days banks have a larger percentage of their funding borrowed in the term markets by issuing CDs, medium-term notes, and even bonds. Since banks manage their tenure mismatch much better, they are not as susceptible to the classic “run on the bank.” However, in recent years, new categories of financial institutions have popped-up that are more susceptible to “bank runs.”

  • Bank Reserves – The decline in bank reserves didn’t cause the Repo panic, but the dwindling supply of reserves could have created a smaller cushion of extra liquidity ready to enter the Repo market. In other words, the amount of excess reserves coming out of the Fed account and into the Repo market is possibly maxed out. Perhaps the bank reserves that are rate sensitive already moved out of the Fed as the IOER rate was cut. What’s left are the reserves that are not rate sensitive and therefore a one-day Repo rate spike is not enough incentive to move that liquidity out

  • Declining excess bank reserves might be the result of Repo market funding pressure and not the cause. Over the past year as Repo rates moved relatively higher and the Fed lowered the IOER, perhaps funds moved out of reserves into Repo just for that reason

  • Modern Day Bank Run – The collateral sellers (shadow banks) need funding. And they need it between 7:00 AM and 8:30 AM. The panic was a classic “run on the bank.” Cash investors did not pull cash out of the market, but they made borrowing cash more expensive. The leverage market participants had no choice but to accept prevailing rates

  • Price Not Credit – At no point during the Repo market panic did credit break down. The market didn’t seize up. Counterparties continued to trade. Just interest rates went higher and higher. In other words, there was never a time when there was no bid for collateral. There was always a bid. The bids just kept moving higher

Though bank balance sheets are constrained by bank regulation, banks are still the main conduit for cash investors and the Federal Reserve to inject cash into the Repo market

Question: Did the Fed solve the Repo funding problem by the size of the operations or the timing? Naturally, most traders assume it’s the dollar amount that eased the Repo panic. Maybe it’s the fact that the Fed plugged the timing mismatch between the collateral sellers and cash providers?

One question that remains unanswered is what sparked the Repo panic? I still believe a block of cash left the market and has not yet returned.