The coronavirus scare is obviously a factor for markets at the moment, but the repo crisis remains in the background too. First question - what are your thoughts on relative (best and worst) asset class performance if the repo crisis flares up on top of the coronavirus pandemic. Second related question - does the coronavirus effect (eg reduced rates, lower company profits, high yield bond risks etc) make it more likely that repo will get worse?

Eoin Treacy's view

Thank you for this question which is particularly relevant against a background of tighter liquidity as banks underperform. Here is Bloomberg’s repo market summary from yesterday:

The New York Fed took $100b of securities in its overnight system repurchase agreement operation Tuesday, according to its website.
* Dealers submitted $108.608b of bids, more than the maximum offering of $100b
* It’s the first time since October the overnight action has been oversubscribed
* N.Y. Fed accepted $69.558b of Treasuries at a stopout rate of 1.60% versus a weighted average rate of 1.607%
* It accepted no agency debt, but accepted $30.442b of mortgage-backed debt at 1.60% with a weighted average rate of 1.601%
* NOTE: In the NY Fed’s term repo operation earlier, dealers took $20b of cash, which was more than three times oversubscribed

As I argued when the Fed initially intervened in the repo market, it is now the first and last port of call for liquidity. That leaves the Fed’s balance sheet open to potentially unlimited liability because the repo market is global in nature. The repo market’s requirement for additional funds necessitates the Fed will need to supply significantly more liquidity and that its balance sheet is likely to continue to trend higher. There is just no way they will be able to persist with their recent policy of restricting liquidity to the repo market.

My custom measure of central bank total assets has broken conclusively higher and has not traded at this level since June 2018.

The weakness of the Dollar, as carry trades have been unwound, is the primary reason for the measure’s breakout.

The TED spread (3-month LIBOR over 3-month Treasury Bills) spike higher during the credit crisis as liquidity evaporated. The measure has certainly been more volatile over the last couple of years but it has stayed depressed and within a narrow band. Nevertheless, it is a spread I am monitoring for any sign of liquidity issues in the money markets.