Goldman Sachs analysts have highlighted a surge in repo rates in the U.S. market, driven by the Federal Reserve's quantitative tightening (QT), large Treasury settlements, election uncertainties, limited intermediary capacity, and the Treasury's refinancing plans. If the Fed maintains its QT policy, further market volatility could ensue.
The recent turmoil in the repo market has captured attention, reminiscent of liquidity challenges faced at the end of last month. The Fed's policies have led to a systemic liquidity crunch, with repo rates spiking to levels seen in 2020. This volatile environment resurfaced as October ended.
Goldman Sachs analyst Vincent Mistretta noted that investors using risk-adjusted strategies showed limited interest in trades with pandemic-era spreads, leading leveraged funds to modestly reduce risk exposure. The current market strain stems from a combination of factors: the Fed's QT, substantial Treasury settlements, election uncertainties, intermediary regulation limitations, and the Treasury's upcoming refinancing plan.
The Treasury will soon settle $531 billion in securities in a single day, marking the third-highest net issuance since late 2021. This scenario is exacerbating market reluctance to engage further with money market risks. Goldman Sachs analyst William Marshall previously warned that supply changes could worsen liquidity tensions as banks show less interest in triparty system borrowing.
Although month-end risk adjustments are generally lighter than quarter-end, Marshall anticipates these changes will elevate short-term financing rates, such as the SOFR, as November begins.
Mistretta emphasized that, despite rising market pressures, the Fed is unlikely to intervene at the last moment. The Fed views current volatility as friction from intermediary operations rather than a liquidity scarcity signal. The ongoing use of the Standing Repo Facility (SRF) could alleviate some bottlenecks, indicating the Fed may continue QT until Q1 2025. If severe repo market lock-ups occur, reminiscent of 2019's turmoil, the Fed might have to act sooner to stabilize the financial system.
The narrowing spreads in short-term Treasuries raise market concerns. Mistretta recalled past events where similar spread levels triggered significant market reactions. Currently, the 3-year swap spread stands at -25 basis points, akin to previous extreme events, urging investors toward caution.
Overall, the combination of fiscal policy uncertainties and market adjustment pressures suggests potential for increased volatility, particularly if repo market tensions persist.
