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A major theme in the markets this past week has been the repo rate hikes and the sudden disappearance of liquidity. Although most are confused as to the main reason, there seems to be a consensus on the underlying drivers:

  1. Corporate tax payments

  2. Treasury coupon auctions

  3. Banks reserves shortfalls

I want to know how exactly the 3 aspects affect liquidity on the repo markets. It does not seem intuitive to me.

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I'll add a little more color.

This week corporations had to pay about $35 billion in corporate tax. When corporations do this they withdraw those funds from the short-term money markets. Essentially the corporations were using this tax payment money to lend short term. They would lend this money to money market funds - who in turn would lend this money to banks via the repo market.

The Treasury also issued more debt, which moved money (reserves) from the accounts of the various banks that bought the debt to the Treasury (which has it's own account at the Fed).

These two factors:

  1. Corporates taking money out of money market funds and
  2. The Treasury taking money out of the banking system

That left banks without the usually supply of short-term cash. And hence the madness ensued.

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The corporate tax payments to the Treasury result in less reserves in the banking system. Similarly , when there is Treasury issuance, reserves leave the banking system. Banks need a certain amount of reserves to function normally and to have enough for a rainy day (eg if there were unexpected withdrawals from depositors). Earlier this week , banks found themselves short of the desired amount of reserves, so they tried to borrow in the repo market. Hence repo rates went up to as high as 9%. Seeing this , the Federal Reserve intervened daily to provide extra reserves through an auction of overnight repos. Subsequently overnight repo has calmed down.

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  • $\begingroup$ I think the primary reason why the Fed intervened was the repo market due to lack of available balance sheet from banks. The corporate tax payments and Treasury settlements coupled exacerbated the demand for funding in the repo particularly given that dealers have a lot of collateral on their balance sheet. As a result, repo rates spike. Participants that normally end in Fed funds found it more attractive to lend in repo so that rather lend in the secured market than in the Fed funds market. Those that needed reserves couldnt find a lender at the funds rate, pushing it higher as well. $\endgroup$ – VanillaCall Sep 21 '19 at 11:51

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