What is the Repo rate and how does it affect markets?

What is Repo rate and what happened in the U.S. money markets recently

Definition: Repo is short for repurchase or repossession.

It is the discount rate at which central banks repurchase government securities from the commercial banks. It depends on the level of money supply it decides to maintain in the country’s monetary system.

Expanding money supply

To expand the money supply temporarily, the central bank will decreases the ‘repo rate’ so banks can then swap their holdings of government securities for cash.

Reducing money supply

To reduce the money supply it increases the repo rates. Alternatively, the central bank decides on a desired level of money supply and lets the market determine the appropriate repo rate.

The lack of cash circulating in short-term money markets has pushed the effective Fed funds rate up, the actual level at which banks lend to each other overnight. This level recently jumped above the interest rate on reserves that banks keep in excess of their reserve requirements.

Temporary measure?

Usually, this is seen as a temporary measure because banks have no real incentive to borrow from another bank when it could simply withdraw funds on deposit at the Federal Reserve.

Market analysts and investors have pointed to this recent jump in the repo rate as the latest reason for higher Fed funds rate.

This key interest rate represents the amount that banks are charged for borrowing funds for a short period of time, in return for collateral such as treasuries. etc.

Rise in repo rates a concern?

Investors get nervous if repo rates increase as they are associated with credit crunches and banking crises.

Repo spike

Repo rates spiked in the 2008 financial crisis when banks didn’t want to to lend to each other. Is this a potential prelude to another problem brewing?