Back on December 31, the day which was the first quarter and year-end after the Fed's first rate hike cycle in nearly a decade, we pointed out something unexpected - the Fed's rate hike corridor had just been broken when the Fed Funds rate traded as low as 0.12%, far below the mandated minimum of 0.25%.
SMRA confirmed as much, and added that "the fed funds rate has dropped to 0.12% this morning, down from 0.47% yesterday. The fed funds rate has dropped at month-end for all of 2015, with some of the larger of these moves occurring at quarter end, like today. It appears that these drops will still occur even after the fed rate hike, and possibly that the will be even more extreme, since today's drop was about 23 basis points, as opposed to previous declines this year, which were usually between 5 and 10 basis points."
It was unclear what had caused this dramatic breach of the Fed's corridor, but we had some ideas:
the fact that there is this kind of major discontinuity in the Fed's rate hike process, throws a huge wrench in the credibilty of the Fed tightening effort.
After all, if banks can steamroll with impunity the Reverse Repo 0.25% floor to park hundreds of billions, or trillions, in liquidity, then the Fed's entire [liquidity soaking] experiment will be worth nothing. Keep in mind, the rate hike process only works if banks don't get a chance to revert to an old standby liquidity regime on the last day of any quarter, in the process getting all the benefits of ZIRP even as the Fed parades just how tight financial conditions are getting.
Just imagine what would happen on December 31, 2016 if the Fed Funds rate plunged from 1.25% to 0.12% overnight? That would suggest that while the Fed may have drained liquidity for 99% of the quarter, on the one day it matters - the day when the bank's balance sheet snapshot is formalized for 10-Q and 10-K purposes, ZIRP regime has returned.
Which is why today, March 31, another quarter and (and the Japanese fiscal year end) we were paying particular close attention to the funding markets, both on the fed funds and the general collateral repo side.
On the fed funds, and reverse repo, side, things we relatively normal: the Fed's reverse repo spiked from $127.1 billion (from 59 counterparties) to $303.8 billion (from 99) overnight. A lot, but we've seen more (and certainly below the expanded ceiling of $2 trillion) and largely to be expected as banks rush to make their balance sheets appear pretty for the regulators, with lots and lots of securities rented from the Fed for 1 day. Fed Funds dipped to 0.25% and briefly slid below it but nothing worth writing home about.
But while FF was "fine", something did break in the general collateral repo market.
Here is Wedbush' Scott Skyrm with a rather scary chart and an attempt at an explanation:
Highest Repo Rate Since The Financial Crisis
An afternoon sell-off in GC pushed overnight rates (on quarter-end) as high as 1.75% and the market ended closed at 1.75%. Drumroll please! The 1.75% rate was the highest GC Repo trade since September, 2008. Naturally, there's was a tightening December which moved rates higher overall. But today, are higher rates a function of the Repo market returing to normal? Or is it a sign of declining liquidity on quarter-end?
And the chart:
What is causing this liquidity scramble we don't know, but such a historic move is most certainly worrying, especially for a Fed that wants to telegraph that all is well with its rate hiking process, and there are no structural liquidity issues with the banks.
Alas, as the chart above clearly shows, not only are there issues, but something clearly has broken in the US market's repo funding plumbing.