Federal Reserve Bank of New York will continue repo offers into February, reduce term operations

THE FEDERAL RESERVE Bank of New York said on Tuesday it will continue to inject liquidity into the overnight lending markets for cash until at least midFebruary while slightly reducing offerings on longer term loans.

The US central bank will modestly pare down the overall scale of the operations after boosting liquidity offerings at yearend, when financial firms and analysts feared a possible shortage of cash.

But the new schedule shows it will stay involved in daily markets for at least another month as it works to permanently increase reserves and keep short rates stable.

“They’re going to err on the side of offering more than the market needs rather than paring back preemptively,” said Zachary Griffiths, a rate strategist for Wells Fargo Securities.

The New York Fed will continue to offer up to $120 billion in daily operations in the market for repurchase agreements, or repo. In February, it will reduce the maximum offerings for longer term loans, which last two weeks, to $30 billion from the current cap of $35 billion.

The New York Fed also said Tuesday it will keep purchasing $60 billion a month in short-term Treasury bills, the same pace set in mid-October when it began growing the balance sheet to permanently increase reserve levels in the banking system.

The update on the Fed’s liquidity operations came as financial firms are showing greater demand for short-term cash loans from the Fed, following a drop at the end of the year.

The central bank’s offering for two-week loans in the repo market was oversubscribed Tuesday morning for the second time since Jan. 7. Firms requested $43 billion in loans on Tuesday, greater than the $35 billion maximum.

The year-end liquidity crunch some experts had anticipated never materialized, and firms took up only a small portion of the repo offerings made available by the central bank in the final days of December. But financial firms now want to know what the Fed’s exit strategy will be after it became a dominant player in the repo market over a four-month period.

The Fed began intervening in the overnight lending markets for cash in mid-September, when a liquidity shortage pushed short-term borrowing costs up to 10%, or more than four times the top of the federal funds target range at the time. The central bank started growing the balance sheet a month later, with the goal of raising reserves to a level where the daily market operations are no longer needed.

Minutes from the Fed’s December policy meeting showed staffers expected they might gradually reduce repo operations after mid-January as it grew the level of reserves. Officials also said the Fed may need to offer some repo support through at least April, when tax payments could lower reserve levels.

Some strategists wonder if the recent rise in demand for the Fed’s repo offerings signals a need for liquidity or if firms are simply taking advantage of low-cost financing from the Fed.

“They’re offering cheaper liquidity than the market so why would dealers not go to the Fed for that funding?” said Blake Gwinn, head of front-end rates strategies for NatWest Markets.

One way to wean firms away from the Fed’s offerings could be to raise the rate charged slightly, Mr. Gwinn said. That could give dealers the incentive to turn to the private market for funding, he said, adding that they could return to the Fed if there was a shortage.

“The Fed should really start communicating and letting people know this is not a permanent state of affairs,” Mr. Gwinn said. —