Jerome Schneider: Ever since the financial crisis of 2008, people have become increasingly focused on the repo markets and funding markets as a signal of deterioration of credit appetite as well as liquidity conditions.
At PIMCO, we've been focused on the repo markets for more than four decades, and as a result, we feel that they are real time barometer of not only the cost of liquidity but also the cost of capital in the marketplace, and utilize them in our short term desk as a proxy for where we think short term rates should be in the context of opportunity sets to invest cash defensively.
With that in mind, repo markets—ever since the repo fiasco of 2019—have really led us to focus on the dynamics of liquidity conditions, and more importantly, the net liquidity that the Federal Reserve has provided us within the short term complex in the repo markets.
While the Fed's Open Market Operations have alleviated a lot of the short term concerns, when we get into periods of stress that we're currently seeing, repo markets are routinely looked at as the source of that stress.
While repo rates are relatively elevated currently, the signs of stress are pretty limited. While we see the appetite for repo collateral growing simply driven by the widening bid offer spreads of certain markets including cash markets, we see it fairly well digested. Simply put, repo markets are functioning, and as a result—although rates are elevated—there's no uncertainty or shortage of liquidity insofar as that the Federal Reserve continues their open market operations as they have continued to do over the past few weeks.
One of the concerns that we have is clearly that repo markets fail, and more importantly, that dealer balance sheets are reduced so that repo market allocations become reduced. But there's no signals of that right now. And many of the concerns that were prevalent in 2008, including counterparty risks, are simply not apparent at this point in time and should not be a concern for investors.
As a result, we actually view repo as being a great investment in terms of overnight repurchase agreements providing a tremendous amount of liquidity on an over-collateralized basis to clients. So as a result, we favor them as a tremendous cash manage opportunity and tool in terms of our daily capital management and capital preservation strategies.
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Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy.
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