September 2019: When Multiple Shocks Meet Scarce Capacity

This chapter reconstructs the September 2019 repo-market disruption as a case of low liquidity meeting simultaneous Treasury-financing and cash-supply shocks. The purpose is not to assign the episode a single cause after the fact. It is to show how a balance-sheet environment can make repo rates unusually sensitive, how a $54 billion coupon settlement can raise funding demand, and how pressure in repo can reach EFFR without making the two markets identical.

The episode is useful because it makes the idea of “capacity” observable. Before the spike, the Federal Reserve had reduced the size of its balance sheet from October 2017 through August 2019. ON RRP balances had reached levels near zero around May 2019, and reserves were less than 9 percent of GDP. The note places that setting in the lowest-liquidity range of its estimates. That did not mechanically determine what would happen next. It meant that the market had less room to absorb a new demand for funding or a temporary withdrawal of cash.

A vulnerable market before the spike

The first part of the story is a change in the background state. Balance-sheet reduction left more Treasury securities to be held by the private sector. Dealers and other investors could finance those positions through repo, but the available buffer on the cash side was thinner once ON RRP balances were close to zero. In the earlier high-ON-RRP case, MMFs could substitute a nonbank balance at the Federal Reserve into repo lending. With that balance largely depleted, additional lending was more likely to require a shift of deposits and reserves through the banking system.

The second part was a demand shock arriving on a predictable settlement date. In mid-September, a $54 billion Treasury coupon settlement increased the demand for repo borrowing. The securities had to be held by someone in the private sector, and the dealers or investors carrying them needed cash against the positions. The settlement therefore did not merely add another number to the Treasury calendar. It concentrated a financing request at a moment when the market’s liquidity buffer was already smaller.

A third part arrived from the opposite side of the market. Corporate tax payments caused money to flow out of banks and MMFs, leaving less money available to fund the increased repo demand. The timing mattered. If a coupon settlement raises the need for cash while tax payments reduce the supply of cash at the same time, borrowers cannot rely on a smooth expansion of lending. The market must find a new balance through higher financing rates, changes in positions, or both.

The sequence can be represented as an interaction of conditions and shocks: