While there has been a plethora of economic and political news driving markets this year, the repo market has been one player that has been taking center stage lately, as it has been linked to problems in the bond markets.
Repo, is short for repurchase agreements, or transactions that amount to collateralized short-term loans, often made overnight. Repo deals permit significant investors like mutual funds to profit through short-term lending of cash that might otherwise sit idle, thereby allowing banks and broker-dealers to get needed financing by loaning out securities they hold in return.
When asked about what has been amiss with markets lately, Samantha Azzarello, JP Morgan ETFs Global Market Strategist explained, “I actually think it was the issues that popped up with repo.”
“We didn’t think the financial plumbing issues are really indicative of anything systemic, right? It’s just liquidity problems. We don’t think it’s solvency issues. But it scared people. And I think it also points to the fact that in the broader bond market we’re going to see liquidity issues going forward,” Azzarello continued.
The Federal Reserve’s Next Steps?
The Fed is likely to step in again as the market could be delicate says the strategist.
“So I mean the New York Fed is going to get back into the open market operations. They’re going to look at the asset and liability pieces of their balance sheet. But really it comes down to the fact that more collateral on the market is probably necessary, especially as funding needs come to call. And I think you put that along with the idea of slowing economic growth, and started issues, and all these different things, and this all feels kind of fragile,” added Azzarello.
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While the steep drop from the fresh highs the market made mid-September is still in play, there may be a more insidious move brewing according to Azzarello.
“Is it possible that we get a 15% decline in the markets this quarter? Absolutely. “I really do think so. Especially if the trade tensions deteriorate, we had that news over the weekend, which was alarming, at best, about stopping capital flows. So if anything I think there’s more downside risk. But I would say it feels very episodic in nature. It feels like the volatility swings are very temporary in nature and then everything just the dues. So I think staying the course is probably key,” Azzarello warned.
Still, it’s not all doom and gloom says the market strategist, as equities typically rebound in the long run.
“I think longer run we always have to make the case for equities. I think if you look at flows year to date, all the money has been going into bonds or cash equivalents. We are all aware of that and there has been massive net out flows out of stocks, speaking to the fact that maybe, you know given flows alone, you have more upside potential for equities,” she noted cautiously.
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