Email

The “Repocalypse” Could Sink the Stock Market Before the Year Ends

0 | By Shah Gilani
Editor’s Note: We’ve been tracking this little-known market for the last 22 months – and we’ve never seen anything like it. There are hundreds of these opportunities being traded every day. And absolutely anyone can capitalize on them. So today, we’re going to blow the lid off this thing – and show you how you can pocket gains like 473%, 631%, even 933%….

It’s out there, that out-of-left-field thing, that exogenous event, that black swan, that thing that could implode the stock market.

Only, it’s not out there, it’s right here.

And it’s got a name: “repocalypse.”

What the smartest, biggest traders in the world are afraid of is an apocalypse in the fed funds market for repurchase agreements (repos); hence, the name is repocalypse.

They’re petrified that extraordinary year-end borrowing by banks and overleveraged hedge funds to meet reserve requirements and settle year-end accounting demands could cause repo borrowing rates to explode and sink the fed funds market, the very plumbing that the financial system lives and dies by.

And that would sink the stock market in about a New York minute.

Here’s what the Federal Reserve’s trying to paper over, what media outlets don’t understand, what’s really happening in the fed funds market, and how a repocalypse could knock the stuffing out of stocks…

Why the Repo Matters So Much to Investors

Every night when banks close their books for the day, every month-end, every quarter, and especially every year-end, they must meet “reserve requirements.” What this means is that they have enough cash on hand to weather potential financial storms they’re prone to. The Federal Reserve determines reserve requirements.

Reserves are different for different banks. The bigger the bank, the bigger the reserve cushion they’re required to maintain.

The biggest banks, also known as the G-SIB monsters (Global Systemically Important Banks), have the highest reserve requirements. And they’re complicated to calculate.

G-SIBs, which includes America’s biggest banks with JPMorgan Chase being the biggest based on its balance sheet, have to break out what kinds of “assets” they have, like Treasury bonds, mortgage backed securities, mortgages, stocks, trading desk securities, derivatives, loans, etc., and have to assign values to each in order to determine what reserves they have to pony up.

One of the assets that banks count is their own stock price. That’s the bank’s equity value. That’s an asset.

The trouble banks are having this year-end is that a lot of their assets have appreciated, while their own stock prices and other stocks that they own have risen. Thus, they’re going to have to add more reserves against those highflying assets.

While on the surface that may not make sense, think about it in reverse.

When equities go up, you’d think that would make them more valuable, which would require fewer reserves to cushion them. At least, that’s what you may think.

In reality the higher they fly, the further they can fall, which is why reserves must go up.

Last year-end, banks didn’t have the problem they have this year of needing more reserves, because the stock market fell precipitously last year from October through December. Thus, their own stock prices and the value of other equities they held fell, requiring fewer reserves be held against them.

But Big Banks Aren’t the Only Ones with This Repo Problem

The same is true for hedge funds, especially super-leveraged hedge funds. The biggest hedge funds that are domiciled in the U.S. have borrowed between five and ten times their capital in order to put on trades to increase their returns. For example, a hedge fund with $20 billion in capital could leverage itself up to own $200 billion in assets.

Just like banks who borrow in the fed funds market by using repos, specifically repurchase agreements where they agree to borrow overnight or for a little longer from other banks, hedge funds use repos to borrow to leverage their balance sheets up.

Banks that need to meet reserve requirements overnight borrow from each other in the fed funds market and generally pay what the Federal Reserve targets the fed funds rate to be.

Currently the fed funds rate is between 1.50 and 1.75%. It’s always a range.

Banks with excess reserves don’t need to lend them overnight in order to earn some interest from other banks who need cash to meet reserve requirements, or to hedge funds who borrow to leverage up returns.

Last year in September the fed funds market kind of blew up.

Banks that bought Treasuries at a big auction had to pay for them on a Monday, which was the same day quarter-end corporate tax payments were due. The result of so much money being drawn out of banks at the same time was a scramble by banks to borrow in the fed funds market to bring in enough cash to meet their reserve requirements.

Some banks had to pay 9%, not anywhere near the 1.50% – 1.75% that the Fed thought they’d be able to borrow. This scramble created a mini panic in the bond market and across borrowing channels.

The Federal Reserve had to come to the rescue to prevent a full-blown panic and hand-over-fist selling of all kinds of assets, including stocks.

If borrowers couldn’t afford to borrow, or if there wasn’t enough money in the system to borrow, liquidation of all kinds of positions would lead to margin calls and a negative feedback loop that could topple markets.

It was scary.

The reason repo costs got so high was because there wasn’t enough money in the system, banks didn’t have enough excess reserves on their books to lend out.

How This All Plays Out in Today’s Markets

Nothing’s changed as we approach year-end.

In fact, equity markets have kept on rising as have banks’ stock prices requiring more reserves. Banks haven’t sold Treasuries for cash which they could lend, they’ve been buying more Treasuries, borrowing in the fed funds market to pay for them.

As banks approach year-end accounting timeframes and have to start looking for cash to meet reserve requirements, at the same time giant over-leveraged hedge funds have to keep rolling over their repos in order to hold onto their positions to mark them at year-end. It’s this strain on repo rates that could cause them to explode again.

If that happens, what will likely happen first is that hedge funds, who might have to pay 9%-10% for short-term loans, would have to sell positions that are too expensive to hold relative to the cost of borrowing to hold them. Then, this situation could beget more selling as other hedge funds, as a lot of the biggest ones would be in the same positions, sell before their competitors sell and knock down their portfolios’ value.

If banks have a hard time borrowing, everyone’s going to know about it immediately. That’s going to panic investors into selling in order to take profits.

But they’ll already be selling into a down market where hedge funds are already dumping securities.

That’s a REPOCALYPSE!

In Monday’s Capital Wave Forecast, I’ll tell you exactly how this is going to play out and what to do.

Sincerely,

Shah

Leave a Reply

Your email address will not be published. Required fields are marked *