Repo market calms after Fed’s steadying call
Fed plans to inject up to Us$75bil to add liquidity
NEW YORK: Let’s do it again.
The Federal Reserve made crystal clear that it doesn’t want US money market rates to spike again like they did early this week, announcing it will – for the third day in a row – inject cash into this vital corner of finance.
The New York Fed will offer up to Us$75bil in a so-called overnight repurchase agreement operation, adding temporary liquidity to restore order in the banking system. It made the same offer Tuesday and Wednesday, deploying a tool it hadn’t used in a decade. This latest action follows the Fed’s reduction in the interest rate on excess reserves, another attempt to quell money-market stresses.
The prior operations have calmed markets, with repo rates declining Wednesday to more normal levels after jumping to 10% on Tuesday, four times where it was last week.
After policy makers wrapped up a two-day meeting, Fed chairman Jerome Powell said Wednesday that the central bank will keep doing these repo operations if that’s what it takes to get markets back on track. He spoke hours after the effective fed funds rate busted through the central bank’s cap, evidence Powell and his colleagues were losing their grip on one of their most important levers for controlling the financial system.
To keep things calm, “the Fed is going to have to keep coming in and doing these operations daily,” said Scott Buchta, head of fixed-income strategy at Brean Capital. “Powell kind of minimised the issues of this week at the press conference, but overall the Fed probably did the best they could do for now to address this. But they will likely need to take more action ahead or at least discuss those plans further at their October meeting.”
Powell also said the Fed would provide a sufficient supply of bank reserves so that frequent operations like the ones they’ve done this week aren’t required.
The only way “to permanently alleviate the funding stress is to rebuild the buffer of reserves in the system,” according to Morgan Stanley strategist Matthew Hornbach.
Relying on repo operations doesn’t resolve the issue of reserves declining as the Treasury rebuilds balances, Hornbach wrote in a note. Having regular operations will also increase market uncertainty as the Fed could halt purchases at any time, while the size of its buying will have to expand over time as reserves drop, he said.
“It is certainly possible that we’ll need to resume the organic growth of the balance sheet sooner than we thought,” Powell said, referring to the central bank potentially buying securities again to permanently increase reserves and ensure liquidity in the banking sector.
Fed policy makers on Wednesday also lowered their main interest rate for a second time this year.
Many strategists had predicted the Fed would take even more aggressive measures to reduce pressures in overnight lending. One idea that’s gotten a fair amount of attention is something called a standing fixed-rate repo facility -- a permanent way to ease funding pressures, as opposed to the ad-hoc operations the Fed has used this week. Many analysts even predicted a Wednesday announcement that the Fed would start expanding its balance sheet.
That didn’t happen. However, with the Fed apparently ready to keep injecting liquidity whenever it’s needed, “it’s enough for now,” said Jon Hill of BMO Capital Markets.
“Though they didn’t announce a standing repo facility, what they did in essence is set up a ‘sitting’ one that can stand up when it needs to,” Hill said. “The market now knows the Fed will come in during stress conditions. So this will kind of operate in the pressure-valve way that was so needed.”