Throughout 2019, banks' end-of-quarter tidying of their balancesheets has resulted in spikes in the U.S. overnight repurchaseagreement (repo) rates. This volatility has set the market on edge. The Federal Reservestepped in, with traders injecting cash into U.S. money markets. Asa result, the last day of the third quarter (Monday) was relatively uneventful in the repo market.

Still, this year's market volatility signals a broader risk. Asa recent report from Fitch Ratings puts it: "While the Fed wasultimately able to stabilize repo dollar funding rates throughad-hoc funding infusions, further repo-market volatility couldexacerbate global liquidity issues, potentially extending to otherasset classes and players beyond the U.S. repo market."

Large banks shouldn't be much affected, both because theirrequired liquidity coverage ratios lead to close matching of repoassets and liabilities, and because they rely more on retaildeposit funding than on wholesale funding sources. However, smallerbroker-dealers, mortgage real estate investment trusts (REITs), andhedge funds may be hit hard if borrowing costs in the repo marketspike and remain high. Exposure to a volatile market for fundingmight also affect those entities' perceived credit risk, whichcould have further ramifications for the economy at large.

On the flip side, lenders in the overnight repo market benefitwhen repo rates rise. In mid-September, money fund investors saw acouple of days of significantly higher yields, with one fundreaching a yield of 5.56 percent.

If repo-market volatility persists, the Fed may have to pull outsome other tools, such as a permanent standing facility, accordingto Fitch Ratings. "This would create an effective ceiling onovernight rates that would allow players in the repo market toobtain sufficient dollar liquidity at reasonable costs," say MonsurHussain, senior  director for financial institutionresearch; Brian Coulton, chief economist; Nathan Flanders, managingdirector for non-bank financial institutions; and Greg Fayvilevich,senior director for funds and asset management. "The possibility ofresuming organic growth in the balance sheet to boost reserves ascurrency demand increases might also be considered."

They conclude: "Keeping price volatility and liquidity risksfrom spreading beyond the U.S. repo market may be especiallyrelevant—and more difficult—with exogenous event risks such asBrexit-related FX [foreign exchange]disturbances or protracted trade wars."