As chaos gripped a key funding market for Wall Street this week, a number of investors seized the moment and took advantage of the surge in short-term borrowing costs to lend a hand to bond dealers, banks and hedge funds feeling the pinch.
Investors wielding spare cash said this week’s troubles in the overnight repo market presented one of those rare opportunities to make hay by lending out as much funds as they could to liquidity-starved traders left scrambling before the Federal Reserve’s pair of liquidity injections.
“We wanted to take advantage of this temporary market dislocation. That was our No.1 focus,” said Eric Souza, senior portfolio manager at SVB Asset Management, in an interview.
When Souza walked onto the trading floor in the early morning hours in San Francisco on Tuesday, he said his team didn’t balk when repurchasing rates soared as high as 8%. Feeling this would be a short-term “market dislocation,” he lent out funds to investors eager to borrow funds through the repo market.
“No one was screaming at our desk, we were just locking in at what levels we could,” said Souza.
The spike in repo rates created havoc for borrowers who use leverage to purchase assets and don’t always have enough cash on hand, which can cause a need for repeat, overnight funding.
See: Here are five things to know about the recent repo market operations
But the opposite was true for investors willing to lend money, while collecting highly creditworthy collateral such as U.S. Treasurys, ensuring that it was a pretty safe bet to place.
“For liquidity providers like us, yesterday was a great day,” said John McColley, a portfolio manager for liquidity strategies portfolios on the short duration and stable value team at Columbia Threadneedle Investments, in an interview Wednesday.
“Where you were seeing rates at 2% for the last several months, all of the sudden you were getting overnight repos at 5%,” he said. “That’s real money to us.”
McColley also said that it’s “nice once in awhile not having the role of liquidity provider being taken for granted.”
The surge in repurchasing rates also spilled over into the overnight commercial paper market, where highly-rated companies borrow funds over a single day.
Nick Maroutsos, co-head of global bonds at Janus Henderson, said he was able to scoop up overnight loans from investment-grade issuers at rates of between 5% to 6% on Tuesday, more than double their levels on last Friday.
Several reasons have been put forth for why liquidity has been drained from the financial system in recent months. Some point to the Federal Reserve’s decision to wind down its balance sheet from crisis-era levels, to Wall Street dealers needing to fund the deluge of Treasury debt to help fund the U.S. fiscal deficit, along with quarterly tax payments from corporations due earlier this week.
But another potential culprit may be unfinished business following the collapse of Lehman Brothers, in which regulators initially sought, but never finalized rules that would have given them a clearer picture of lenders’ exposure to repurchase agreements.
Check out: SEC never finalized repo disclosure rule that would give investors more info
However, there are a few things the week’s tumult has brought to light.
For one, the Fed appears capable and keen to keep control over overnight funding rates and credit flowing.
Fed Chair Jerome Powell, speaking Wednesday after the central bank’s rate-setting committee voted to cut interest rates by a quarter-point to a range of 1.75% to 2%, said the recent spike in money market funding was due to forces that the Fed saw were coming, even if they had not seen the magnitude of borrowing needs that cropped up.
To that end, Powell said the Fed had tools to address additional funding pressures that arise, and will be prepared to use them. Late Wednesday, for the third time this week, the Fed announced another repo operation for Thursday morning in order to provide liquidity to short term funding markets. Powell also noted that the Fed will assess if there is a need to organically grow its balance sheet.
How big is the current liquidity hole in the market ?
“My guess,” said McColley, using an estimate based on demand already seen from the two Fed facilities, “is that it could be $100 billion to $150 billion.”
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