Scott Skyrm on the Dynamics of the Repo Market in 2021

Episode Summary

Executive Summary: The episode explores the repo market’s evolution, function, and recent stress points through the lens of veteran practitioner Scott Skirm. He explains repo as the secured funding backbone of Treasury markets, discusses how regulation and market structure shifted activity from banks to independents, and argues that SOFR and repo are increasingly central while Fed funds is becoming outdated. He also reviews the 2019 repo spike and March 2020 turmoil as leverage/liquidity events.

Main Topics: What the repo market is and why it matters (Priority: 5/5): Skirm defines repo as a collateralized loan linking cash investors and leveraged holders of Treasuries, emphasizing its role in liquidity, funding, and market functioning. Career path into repo and market evolution (Priority: 3/5): He describes starting in Wall Street operations in 1989-1990 and how decades of market change, regulation, and growth in Treasury issuance shaped repo’s expansion. Repo, SOFR, and the decline of Fed funds (Priority: 5/5): The discussion contrasts secured overnight funding with the shrinking unsecured Fed funds market and argues that SOFR is becoming the more relevant reference rate. Regulation and the rise of independent repo broker-dealers (Priority: 4/5): Skirm explains how Basel III, Dodd-Frank, leverage ratios, and balance-sheet costs pushed banks to reduce repo activity, creating space for firms like Curvature Securities. Negative repo rates and supply-demand dynamics (Priority: 4/5): He explains that negative rates can arise from Treasury scarcity, high demand for collateral, and the interaction of Treasury issuance and Federal Reserve asset purchases. Repo market stress events: 2019 and 2020 (Priority: 5/5): The 2019 repo spike and the March 2020 liquidity shock are presented as episodes driven by leverage, collateral scarcity, and crowded trades unwinding simultaneously. Market structure and future reforms (Priority: 4/5): Skirm argues the market already has central clearing, rate floors and ceilings, and suggests the bigger reform is replacing Fed funds with SOFR as policy anchor.

Key Arguments: Repo is the secured overnight funding market that lubricates the broader financial system and helps finance Treasury holdings and leveraged positions. The growth of Treasury issuance has expanded repo’s size and importance, while the old Fed funds market has become thin and less representative. Banks retreated from repo after post-crisis regulation increased capital and leverage costs, enabling independent broker-dealers to fill the gap. Negative repo rates are not unprecedented; they reflect supply-demand imbalances, especially when high demand for safe collateral meets limited Treasury supply. The Fed’s balance sheet actions matter: Treasury issuance adds securities while Fed purchases remove them, influencing repo rates and collateral availability. September 2019 showed how a cash shortage plus heavy Treasury financing needs can trigger a sharp repo spike; the Fed’s backstop facilities were crucial. March 2020 was largely an unwind of crowded leverage and basis trades, with hedged Treasury/futures positions under stress as spreads widened. Fed funds is increasingly irrelevant as a trading market, and SOFR is the natural successor as a policy benchmark because it is tied to secured overnight funding. Central clearing concerns are less of a structural gap than often claimed because FICC already performs central clearing for much of the market.

Data Points: U.S. Treasury repo market size: about $5 trillion - Skirm’s estimate of the overall repo market scale U.S. Treasury market size: $20+ trillion - He cites the broader Treasury market as the collateral base feeding repo Repo desk profit spread: about 5 basis points - He notes repo is a low-margin business for banks and broker-dealers Fed funds market size: about $70 billion a day - He describes the Fed funds market as thin and much smaller than repo Treasury issuance pace: about $200 billion net new securities per month - Used to explain supply pressure on repo rates Fed balance-sheet runoff/purchases: about $120 billion per month net securities out of the market - He frames Fed buying as removing collateral and affecting rates TGA balance: about $1.5 trillion in August; normal level about $400–500 billion - Treasury General Account buildup and expected drawdown are discussed as market-liquidity factors Treasury TGA target by end of June: about $400 billion - Expected normalization path cited by Skirm Stimulus checks already distributed: about $250–275 billion - He says part of the $1.9 trillion stimulus quickly moved into the economy Treasury collateral vs Fed funds spread: about 4 basis points below Fed funds - He uses the spread as a gauge of collateral demand and market saturation September 2019 repo spike: up to 9% on one day - He cites the extreme intraday funding stress during the repo crisis September 2019 spread comparison: general collateral 10–15 basis points over Fed funds - He contrasts this with later periods when GC traded below Fed funds Lone rate floor/ceiling facilities: RRP rate raised to act as a ceiling - He says the Fed adjusted the overnight reverse repo facility to cap rates

Pivotal Quotes: "the repo market is the oil that lubricates the engine of the financial markets that help power the economy of the vehicle" — Scott Skirm: Explaining repo’s systemic importance to market functioning "I think that the Fed achieved what they wanted to achieve by keeping that rate above the market so that it's a penalty rate, but it's there in case, you know, rates spike" — Scott Skirm: Discussing the Fed’s reverse repo facility as a market backstop "I will give you a great reform that we need. They need to get rid of the Fed funds rate by now" — Scott Skirm: Arguing that Fed funds is no longer a meaningful policy benchmark

Implications: Repo is increasingly the key overnight funding market for Treasuries and short-term liquidity. Listeners should expect continued SOFR growth, possible Fed-funds obsolescence, and recurring stress whenever collateral supply, leverage, or cash conditions tighten.