Throughout 2019, banks' end-of-quarter tidying of their balance sheets has resulted in spikes in the U.S. overnight repurchase agreement (repo) rates. This volatility has set the market on edge. The Federal Reserve stepped in, with traders injecting cash into U.S. money markets. As a 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. As a recent report from Fitch Ratings puts it: "While the Fed was ultimately able to stabilize repo dollar funding rates through ad-hoc funding infusions, further repo-market volatility could exacerbate global liquidity issues, potentially extending to other asset classes and players beyond the U.S. repo market."
Large banks shouldn't be much affected, both because their required liquidity coverage ratios lead to close matching of repo assets and liabilities, and because they rely more on retail deposit funding than on wholesale funding sources. However, smaller broker-dealers, mortgage real estate investment trusts (REITs), and hedge funds may be hit hard if borrowing costs in the repo market spike and remain high. Exposure to a volatile market for funding might also affect those entities' perceived credit risk, which could have further ramifications for the economy at large.
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