By Davide Barbuscia
A recent surge in the Secured Overnight Financing Rate (SOFR) has sparked concerns about liquidity in the U.S. repurchase agreement (repo) market. However, Deutsche Bank suggests that this increase may be due to a calculation quirk rather than a shortage of cash.
According to New York Federal Reserve data, SOFR rose to 5.38% on Monday, its highest level since July, but remained unchanged on Tuesday. This rate is a crucial indicator of borrowing costs in the repo market, where banks and other participants secure short-term funding.
Deutsche Bank's analysts believe that the recent spike in SOFR does not reflect broader funding market pressures, unlike the situation in 2019 when the Federal Reserve intervened to inject liquidity. They attribute this anomaly to the methodology used to calculate SOFR.
SOFR is determined by the volume-weighted median rate of repo transactions, excluding rates below the 25th percentile. This exclusion can have a significant impact on the final SOFR calculation, as highlighted by Deutsche Bank's analysis.
The bank's analysts propose a scenario where a minor adjustment in the rate of a single repo transaction leads to a notable increase in the calculated median rate. They also mention upcoming changes to the SOFR calculation methodology, aimed at mitigating the influence of rate distribution on the final result.
Overall, while the recent rise in SOFR may not be a cause for immediate concern, investors should stay informed about potential changes in the repo market. Understanding the intricacies of key financial indicators like SOFR can help individuals make informed decisions about their investments and financial planning.