Posted 12/6/2023, 1:56:00 AM
Repo Market Turmoil Highlights Risks as Fed Unwinds Balance Sheet
- Recent spikes in short-term interest rates are reminiscent of funding turmoil in Sept 2019 that caused the Fed to lose control of rates temporarily
- The spikes were caused by a surge in demand for repo financing due to the recent Treasury bond rally, exacerbated by banks paring back lending for regulatory reasons
- The dysfunction highlights the vital role of repo markets in enabling central banks to manage monetary policy and keeping borrowing costs low
- While bank reserves remain abundant for now, the issues suggest balance sheet capacity will become more critical as quantitative tightening continues
- If excess liquidity continues declining rapidly, risks of further funding strains may mount heading into 2024