The government shutdown lasts 6 days: What repo and financial risks should be monitored?

As the U.S. government faces the risk of shutdown in the next 6 days, financial markets must confront a series of underlying risks that many investors are not fully aware of. Unlike previous shutdowns, this one occurs when the financial system is already under stress. In particular, the Repo market — an essential but often overlooked market — is becoming a key point to monitor.

What is the Repo market and why is it important to the financial system?

A Repo (Repurchase Agreement) is a short-term lending mechanism used by banks and traders to boost liquidity. Simply put, a Repo allows financial institutions to sell securities with an agreement to buy them back after a short period. This is the lifeblood of the global money markets.

The Repo market operates smoothly when there is trust among traders. However, when the government shuts down, economic data disappears — no employment reports, no CPI figures. The lack of this information creates significant uncertainty. The Federal Reserve’s risk models also cease to function. As a result, Repo spreads spike, and the Repo market begins signaling stress.

Four risk scenarios from the loss of economic data

Loss of economic information. No CPI means the market loses signals about inflation. No employment reports mean no insight into the labor market. Without this data, the VIX (market volatility index) must be priced higher to reflect increased uncertainty.

Risks from collateral assets. With credit warnings ongoing, a shutdown could lead to credit downgrades. A spike in Repo spreads is the first warning sign. When traders lose confidence in asset quality, liquidity in the Repo market can quickly collapse.

System-wide liquidity freeze. The RRP (Reverse Repo Program) buffer — the last tool for the central bank to inject cash into the system — has been exhausted. No safety net remains. If traders start hoarding cash, the Repo market will freeze, spreading across the entire financial system.

Triggering an economic recession. Each week of shutdown reduces GDP by about 0.2%. When the economy slows down, this figure is enough to push it into technical recession — two consecutive quarters of negative growth.

How to monitor the SOFR-IORB spread: An early warning of Repo crisis

During major financial stress periods, the spread between SOFR (Secured Overnight Financing Rate) and IORB (Interest on Reverse Repo Balances) is a precise warning indicator. When this spread begins to widen, it indicates that private markets are short of cash while the Federal Reserve is sitting on a pile of money — a dangerous imbalance.

Monitoring the SOFR-IORB spread is the best way to detect early issues with the Repo market. If this spread starts to expand, it signals that the financial system is under stress.

Comparing with the 2020 crisis: Lessons from the past

The last time a similar situation occurred was in March 2020, when the pandemic shocked the financial markets. At that time, the SOFR-IORB spread spiked abruptly. The Federal Reserve had to intervene heavily, pumping billions of dollars into the Repo market to stabilize the situation.

This time, with the government shutdown, there is no new data to support policy decisions by the Federal Reserve. This adds to the complexity. However, based on the 2020 experience, policymakers can act more quickly if early signs of stress are detected — especially through the Repo market.