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By Cleo Chang
For a $3+ trillion market, “repos” generally don’t get much attention from investors—even from those who are familiar with the term.
Repos, short for repurchase agreements, are a form of short-term borrowing. These deals allow one party to lend cash in exchange for debt instruments, such as Treasury bills and other government securities, often overnight. The borrower can then repurchase the securities, and the small difference in price is known as the repo rate.
Most of the time, this process happens behind the scenes. But what happens when the repo market doesn’t work as intended? Watch my latest video to hear more on the important role repurchase agreements have recently played in investment markets.
Investor typically don’t pay close attention to repo, unless the repo rate makes a sharp jump that is outside of the expectation. And sometimes gets the Fed to come in and reassess the liquidity needs and may decide to either inject or pull out cash from the market to allow the repo market to return to normal.
Repo market is the short term for repurchase agreement market. And what this really is, particularly in the U.S., is an overnight cash and collateralized asset exchange facility. As an example, there’s a lot of U.S. money market funds that hold a lot of cash as investors put money into the fund. And there are a lot of banks that hold short-term debt instruments like the Treasury bill.
But because banks are under certain regulations and need to have certain cash reserves requirements overnight, they would need to seek out a cash facility to lend them the cash where they can collateralize their short-term Treasury bills as collateral. So that’s what happens in the general in the repo market overnight.
What is a surprising fact for many investors might be that the amount of dollars that exchange hands in the repo market and the reverse repo market on a daily basis is typically north of $3 trillion. So, it’s a very active market; it’s a very important component of our capital markets that provides a lot of short-term liquidity that allows other things to work the way they’re supposed to.
When the repo market doesn’t work as it’s intended to, the first sign usually is that the repo rate—which is the rate that the bank who has the asset, the debt asset, and the mutual fund or other financial entity that has the cash, the interest rate that they use to exchange that transaction—will start to rise.
That does happen on a regular basis; there are certain market events that will typically create more demand for that overnight cash than others. So, it does happen from time to time.
Get additional insights in our latest Investment Outlook.
Liquidity, volatility and credit spreads may all have a role to play in the year ahead, according to Head of Investment Solutions Cleo Chang.
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November 14, 2018
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