18Sep2019 - Thomas Poh
The recent spike in USD overnight repo rates is widely attributed to US corporate tax payment activities as well as the reduction in the Fed balance sheet which resulted in subsequent reduction in US banks cash reserves. As result, the Fed had to inject USD 75bio into the overnight market more than once in order to ease the squeeze.
This event cast new light on the significance of the Secured Overnight Funding benchmark (SOFR) and SOFR Futures which was adopted in 2017 as the alternative to the now infamous LIBOR,. Fed Fund futures (and on the same note USD OIS) has been proven to be ineffective in its use as an hedge against USD overnight funding risks. SOFR, which is calculated based on transactions derived from the very same squeezed repo market, is a direct measurement of this funding risk. As such, CME SOFR futures and SOFR OIS are a more natural hedge against actual repo funding risk. Similarly, SOFR vs Fed Futures spread will be a key barometer of funding conditions going forward