Yesterday we showed what was arguably the strangest move that took place on the last trading day of 2018, when the overnight general collateral repo rate shot up from 2.5% last Friday to as high as 6.125% on Monday, the biggest one day move on record, bringing overnight GC repo to the highest level since January 2001.

While violent year-end moves are well-known in the overnight funding markets, the magnitude of yesterday's surge was simply unprecedented, and commenting on the GC Repo surge, Scott Skyrm, EVP at Curvature Securities said that "the cash never came in," noting that while "funding pressure should be about 50 basis points" and yet what we got was "350 basis points."

While clearly there was something amiss with year end liquidity - in a day in which the 1 Year yield closed above both 5Y and 7Y yields - the record spike in repo still left rates traders scratching their heads, with Skyrm warning that market participants may have to start pricing in the fact that if repo rates "spike up a bit, they could go much higher."

He was right, because one day after GC repo normalized on January 1, it has since exploded higher once again, and on Wednesday, the overnight GC repo rates spiked again, and this time one couldn't blame it on year-end funding pressures for the simple reason that it is no 364 days until the next year-end.

As shown in the chart below, GC was averaging about 3.25% as of 8:30am ET, according to Nex data after averaging 3.50% at the 8am open after dropping back to 2.50% on Tuesday, and rising as high as 4.525% on January 2, after the new year.

Commenting on the move, Stone & McCarthy said that overnight GC has been “very volatile again already this morning,” ranging anywhere from 3.30% to above 4%, in a move which was not supposed to happen if all the Dec 31 volatility reflected was year-end "window dressing" liquidity plumbing (again: it's now Jan 2).

Another attempt to explain these unprecedented moves came from Wrightson ICAP economist Lou Crandall, who said that the confluence of declining reserves at the Fed, banks’ increasing presence in Treasury repo and the same institutions pulling back at year-end to shore up balance sheets led to an “eye-popping” surge in the overnight funding rate on Monday.

Furthermore, with the supply of Fed balances declining, banks have increased their Treasury repo investments to meet liquidity objectives; in other words the year-end surge was merely a reflection of regulatory requirements. And, as Bloomberg further notes, "one complication is that these same banks tidy their balance sheets at year-end when regulatory surcharges are calculated. As part of their bid to lessen these regulatory imposts, banks tend to pare their exposure to repo, which in turn makes it more expensive for borrowers."

Others also chimed in, with TD Securities rate strategist Gennadiy Goldberg also blaming the confluence of shrinking reserves, regulatory requirements and year-end window dressing: 

“It was an atypical but typical year-end, because bank balance sheets were even more scarce than people thought,” Goldberg said, adding that it "isn’t a funding issue, it’s balance-sheet scarcity that was worse than expected."

Which is great... but what about Wednesday's surge and the failure to return to the recent normalcy range around 2.5%?

Well, nobody really knows, although according to Wrightson, if banks "pare back their repo market exposures all at once, the market will be flooded with surplus collateral suddenly in need of a home and the price of balance sheet will skyrocket over the course of a day."

And this is precisely what is happening on Wednesday, even though Wrightson said that it expects much of Monday’s pressure to fade over the course of the morning. Alas, instead of fading, funding pressure - or balance sheet scarcity - has clearly persisted in a critical move for the repo market that has so far stumped all those who expected Monday's record surge to be nothing but a memory by today.