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Is a repeat of the 2019 repo crisis brewing?

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Is a repeat of the 2019 repo crisis brewing?

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At the end of September there was a big spike in the Secured Overnight Financing Rate. This may already be putting you to sleep but it’s potentially a big deal, so please stick around.

SOFR was created to replace Libor (R.I.P.). It measures the cost of borrowing cash overnight, collateralised with US Treasuries, using actual transactions as opposed to Libor’s more manipulation-prone vibes. You can think of it as a proxy of how tight money is at any given time.

Here you can see how SOFR generally traded around the central point of the Federal Reserve’s interest rate corridor, and fell when the Fed cut rates by 50 basis points in September. But on the last day of the month, it suddenly spiked.

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This is natural, to an extent. There’s often a bit of money tightness around the end of the quarters, and especially the end of the year, as banks are keen to look as lean as possible heading into reporting dates. So SOFR (and other measures of funding costs) will often spike a little around then.

But this was FAR bigger than normal. Here is the same chart but showing the end-of-2023 spike, and little dimples at the end of the first and second quarters.

Indeed, Bank of America’s Mark Cabana estimates that this was the single-biggest SOFR spike since Covid-19 wracked markets in early 2020, and points out it happened on record trading volumes.

Cabana says he was initially too hasty in dismissing the spike as driven by a short-term collateral shortage and unusually large amounts of window-dressing by banks. In a note published yesterday, he admits to overlooking something potentially more ominous: reserves seeping out of the banking system.

We have long believed funding markets are determined by 3 key fundamentals: cash, collateral, & dealer sheet capacity. We attributed last week’s funding spike to the latter 2 factors. We overlooked extent of cash drain in contributing to the pressure.

The increased sensitivity of cash to SOFR hints of LCLOR.

LCLOR stands for “lowest comfortable level of reserves”, and might require a bit more explanation.

Back in ye olde times (pre 2008), the Fed set rates by managing the amount of reserves sloshing around the US monetary system. But since 2008 that has been impossible due to the amount of money pumped in through various quantitative easing programmes. That has forced the Fed to use new tools — like interest on overnight reserves — to manage rates in what economists call the “abundant reserve regime”.

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But the Fed has now been engaging in reverse-QE — or “quantitative tightening” — by shrinking its balance sheet sharply since 2022.

The goal is not to get the balance sheet back to pre-2008 levels. The US economy and financial system is far larger than it was then, and the new monetary tools have worked well.

The Fed just wants to get from an “abundant” reserve regime to an “ample” or “comfortable” one. The problem is that no one really knows exactly when that happens.

As Cabana writes (with FT Alphaville’s emphasis in bold below):

Like the macro neutral rate, LCLOR is only observed near to or after it is reached. We have long believed LCLOR is around $3-3.25tn given (1) bank willingness to compete for large time deposits (2) reserve / GDP metrics. Recent funding vol supports this.

A similar dynamic was seen in ‘19. At that time, the correlation of changes in reserves to SOFR-IORB turned similarly negative. The sensitivity of SOFR to reserves correlation signalled nearing LCLOR. We sense a similar dynamic is present today.

Unfortunately, when reserve levels drop to uncomfortable levels, we tend to find out very quickly, in unpleasant ways.

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Cabana’s mention of 2019 is a reference to a repo market crisis in September that year, when the Fed missed growing hints of tightness in money markets. Eventually it forced the Federal Reserve to inject billions of dollars back into the system to prevent a broader calamity. MainFT wrote a superb explainer of the event, which you can read here.

In other words, the recent SOFR spike could be a hint that we are approaching or already in uncomfortable reserve levels, which could cause a repeat of the September 2019 repo ructions if the Fed doesn’t act preemptively to soothe stresses.

Here are Cabana’s conclusions (his emphasis):

Repo is heart of markets. EKG measures heart rate & rhythm. Repo EKG flags shift. Cash drain has supported spike in repo. Fed should take repo pulse & sense shift. If Fed too late to diagnose, ‘19 repeat. Bottom line: stay short spreads w/Fed behind on diagnosis.

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Trump claims US stockpiles mean wars can be fought ‘forever’; Kristi Noem testifies before Congress – US politics live

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Trump claims US stockpiles mean wars can be fought ‘forever’; Kristi Noem testifies before Congress – US politics live

Trump says US stockpiles mean “wars can be fought ‘forever’”

In a late night post on Truth Social, Donald Trump said that the US munitions stockpiles “at the medium and upper medium grade, never been higher or better”.

He added that the US has a “virtually unlimited supply of these weapons”, meaning that “wars can be fought ‘forever’”.

This comes after Trump said that the US-Israel war on Iran could go beyond the four-five weeks that the administration initially predicted. The president also did not rule out the possibility of US boots on the ground in Iran during an interview with the New York Post on Monday.

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“I rebuilt the military in my first term, and continue to do so. The United States is stocked, and ready to WIN, BIG!!!,” he wrote.

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Key events

During his opening remarks, Senate judicicary committee chairman, Chuck Grassley, blamed Democrats for the ongoing shutdown Department of Homeland Security (DHS) but highlighted four agencies: the Secret Service, Federal Emergency Management Agency (FEMA), the Transportation Security Administration (TSA), and the Coast Guard.

Democrats are demanding tighter guardrails for federal immigration enforcement, but a sweeping tax bill signed into law last year conferred $75bn for Immigration and Customs Enforcement (ICE), which means the agency is still functional amid the wider department shuttering.

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Supreme Court blocks redrawing of New York congressional map, dealing a win for GOP

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Supreme Court blocks redrawing of New York congressional map, dealing a win for GOP

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Win McNamee/Getty Images

The Supreme Court on Monday intervened in New York’s redistricting process, blocking a lower court decision that would likely have flipped a Republican congressional district into a Democratic district.    
  
At issue is the midterm redrawing of New York’s 11th congressional district, including Staten Island and a small part of Brooklyn. The district is currently held by a Republican, but on Jan. 21, a state Supreme Court judge ruled that the current district dilutes the power of Black and Latino voters in violation of the state constitution.  
  
GOP Rep. Nicole Malliotakis, who represents the district, and the Republican co-chair of the state Board of Elections promptly appealed to the U.S. Supreme Court, asking the justices to block the redrawing as an unconstitutional “racial gerrymander.” New York’s congressional election cycle was set to officially begin Feb. 24, the opening day for candidates to seek placement on the ballot.  
  
As in this year’s prior mid-decade redistricting fights — in Texas and California — the Trump administration backed the Republicans.   
 
Voters and the State of New York contended it’s too soon for the Supreme Court to wade into this dispute. New York’s highest state court has not issued a final judgment, so the voters asserted that if the Supreme Court grants relief now “future stay applicants will see little purpose in waiting for state court rulings before coming to this Court” and “be rewarded for such gamesmanship.” The state argues this is an issue for “New York courts, not federal courts” to resolve, and there is sufficient time for the dispute to be resolved on the merits. 
  
The court majority explained the decision to intervene in 101 words, which the three dissenting liberal justices  summarized as “Rules for thee, but not for me.” 
 
The unsigned majority order does not explain the Court’s rationale. It says only how long the stay will last, until the case moves through the New York State appeals courts. If, however, the losing party petitions and the court agrees to hear the challenge, the stay extends until the final opinion is announced. 
 
Dissenting from the decision were Justices Sonia Sotomayor, Elena Kagan, and Ketanji Brown Jackson. Writing for the three, Sotomayor  said that  if nonfinal decisions of a state trial court can be brought to highest court, “then every decision from any court is now fair game.” More immediately, she noted, “By granting these applications, the Court thrusts itself into the middle of every election-law dispute around the country, even as many States redraw their congressional maps ahead of the 2026 election.” 

Monday’s Supreme Court action deviates from the court’s hands-off pattern in these mid-term redistricting fights this year. In two previous cases — from Texas and California — the court refused to intervene, allowing newly drawn maps to stay in effect.  
  
Requests for Supreme Court intervention on redistricting issues has been a recurring theme this term, a trend that is likely to grow.  Earlier last month  the high court allowed California to use a voter-approved, Democratic-friendly map.  California’s redistricting came in response to a GOP-friendly redistricting plan in Texas that the Supreme Court also permitted to move forward. These redistricting efforts are expected to offset one another.     
   
But the high court itself has yet to rule on a challenge to Louisiana’s voting map, which was drawn by the state legislature after the decennial census in order to create a second majority-Black district.  Since the drawing of that second majority-black district, the state has backed away from that map, hoping to return to a plan that provides for only one majority-minority district.    
     
The Supreme Court’s consideration of the Louisiana case has stretched across two terms. The justices failed to resolve the case last term and chose to order a second round of arguments this term adding a new question: Does the state’s intentional creation of a second majority-minority district violate the constitution’s Fourteenth and Fifteenth Amendments’ guarantee of the right to vote and the authority of Congress to enforce that mandate?    
Following the addition of the new question, the state of Louisiana flipped positions to oppose the map it had just drawn and defended in court. Whether the Supreme Court follows suit remains to be seen. But the tone of the October argument suggested that the court’s conservative supermajority is likely to continue undercutting the 1965 Voting Rights Act.   

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Map: Earthquake Shakes Central California

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Map: Earthquake Shakes Central California

Note: Map shows the area with a shake intensity of 3 or greater, which U.S.G.S. defines as “weak,” though the earthquake may be felt outside the areas shown.  All times on the map are Pacific time. The New York Times

A minor earthquake with a preliminary magnitude of 3.5 struck in Central California on Monday, according to the United States Geological Survey.

The temblor happened at 7:17 a.m. Pacific time about 6 miles northwest of Pinnacles, Calif., data from the agency shows.

As seismologists review available data, they may revise the earthquake’s reported magnitude. Additional information collected about the earthquake may also prompt U.S.G.S. scientists to update the shake-severity map.

Source: United States Geological Survey | Notes: Shaking categories are based on the Modified Mercalli Intensity scale. When aftershock data is available, the corresponding maps and charts include earthquakes within 100 miles and seven days of the initial quake. All times above are Pacific time. Shake data is as of Monday, March 2 at 10:20 a.m. Eastern. Aftershocks data is as of Monday, March 2 at 11:18 a.m. Eastern.

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