Repo Rate Spike: A ‘Tail’ Of Low Liquidity

Markets can prove interesting when the price of liquidity abruptly increases and high yield is no longer the highest-yielding investment.

Banks’ “reporting” dates are known inflection points in the short-term funding markets and typically fall at the end of the month, quarter, and of course the year. But periodically, the 15th of the month is also a pressure point. Such was the case this past Monday when a short-term funding rate that had been hovering around 2.21% soared as high as 10%.

The funding market succumbed to a trifecta of pressures:

  1. Payments on corporate taxes were due on 15 September, leading to high redemptions of more than $35 billion in money market funds.
  2. Cash balances increased by an additional $83 billion in the U.S. Treasury general account, which reduces excess reserves and simultaneously acts to reduce the aggregate supply of overnight liquidity available in funding markets.
  3. Dealers needed an additional $20 billion in funding to finance the settlement of recent scheduled U.S. Treasury issuance.

None of these pressures was extraordinary or unforeseen, but together they had an extraordinary impact.

At the source: the Fed’s lower reserves

In our view, the repurchase (repo) market, where banks and broker-dealers can obtain overnight collateralized loans from intermediaries, is a critical barometer of the health of the financial markets. This week’s events demonstrated that the funding markets overall are increasingly susceptible to large changes in flows from the supply side even if the demand for funding does not change much.

On September 15, as so many institutions needed funding, repo rates climbed well above the fed funds upper-end target at the time of 2.25% to briefly touch 5%. The following day, cash repo markets traded as high as 10% for those looking to finance agency mortgage positions overnight. Later that morning, the Federal Reserve Bank of New York acknowledged the pressures and conducted its first Open Market Operation (OMO) in more than a decade to add reserves to the funding markets that were clearly in need of the liquidity. Subsequently, after its meeting Wednesday, the Federal Open Market Committee (FOMC) announced a cut in the interest on excess reserves (IOER) of 0.30% – five basis points more than its cut in the fed funds rate – providing some relief to the upper bound of money-market yields. Even after this, however, funding costs have remained elevated, which suggests that additional steps are likely to be considered, including term funding facilities. 

We expect these episodes of funding stresses to become more frequent with demand for funding and U.S. Treasury supply forecast to increase heading into year-end and the Fed’s reserve levels likely to drop further. Over the past two years as the Fed has undertaken “quantitative tightening,” its reserves have declined to $1.4 trillion from $2.3 trillion in August 2017. 

Meanwhile, since June 2018, banks’ holdings of U.S. Treasuries have more than doubled to over $200 billion from $100 billion. These holdings have been financed by money market funds which have increased their repo investments by over $300 billion this year alone, based on data from the Investment Company Institute. While providing a timely source of funding that helps offset the increasing demand, this reliance leaves the U.S. funding markets more fragile if money market fund outflows occur.

What does it mean for investors?

We think investors should be prepared for deteriorating liquidity in the funding markets into year-end and the impact of this on the financial markets as a whole, with potential costs for levered strategies and risk assets in particular. While we expect that the Fed will continue to monitor these signals and ultimately take actions to help ease such pressures, there are seasonal and systemic factors that may continue to impact funding levels (in relative and absolute terms) for end users over the cyclical horizon. And as we saw in the fourth quarter last year and were reminded of this week, market conditions can change dramatically with little warning.

In reaction to these market changes, PIMCO has been actively evaluating and aiming to optimize client portfolios to either invest capital at these higher yields or minimize the funding costs by shifting to less impacted markets. From a broader investment perspective, market participants who have excess cash and can provide liquidity to the short-term funding markets may benefit. The front end of the yield curve and short-term cash markets – including repos – may offer attractive opportunities for risk-averse investors in the months ahead. For the past month, elevated repo rates combined with an inverted yield curve have provided investors with relatively high income potential and a low volatility profile. As the past few days have shown, current market liquidity conditions warrant defensive positioning overall but can also present opportunities for investors who are in a position to take them.

Jerome Schneider is PIMCO’s head of short-term portfolio management. William Martinez and Jerry Woytash are portfolio managers on the short-term desk. 

The Author

Jerome M. Schneider

Head of Short-Term Portfolio Management

William Martinez

Portfolio Manager, Short-Term Desk

Jerry Woytash

Portfolio Manager, Short-Term Desk



PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the Securities Institutions Act (WplG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH- . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and a low interest rate environment increases this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Short-term investments will be more volatile than traditional cash investments and their value will fluctuate. Short-term strategies are not federally guaranteed and may lose value.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.