What Explains Month-End Funding Pressure in Canada?
Historically, the Canadian overnight repo market persistently showed signs of funding pressure around month-end periods. Both the overnight repo rate and the Bank of Canada liquidity provision tend to rise in these windows.
This paper proposes three hypotheses to explain this phenomenon. First, month-end funding pressure may be caused by search frictions. Market participants place a premium on liquidity around month-end periods because of the confluence of a generalized liquidity preference, heightened month-end forecast uncertainty and resultant search frictions in the repo market. Second, this funding pressure could be attributed to spillovers from the US overnight repo market. Third, month-end funding pressure might be associated with end-of-month repo adjustments of large Canadian banks.
Combining market, central-bank and payments data, this paper provides evidence that the first hypothesis explains the latent funding pressure observed on the first day of the month. Using market and non-public regulatory data, the paper also argues that the second and third hypotheses are much less plausible.