Fed to inject $75bn into financial system

The Federal Reserve said it would inject $75bn into the financial system to staunch a sharp rise in US short-term funding costs. /

The Federal Reserve said it would inject $75bn into the financial system to staunch a sharp rise in US short-term funding costs.

The cost of borrowing cash in exchange for US Treasuries overnight using repurchase agreements — known as repos — surged on Tuesday to as high as 10%, according to global provider of financial markets data and infrastructure Refinitiv.

That dragged the effective federal funds rate higher to 2.25%, the very top of the Fed ’ s targeted range of 2%-2.25%.

REPO OPERATION

In response, the New York Fed, which conducts market operations for the central bank, said on Tuesday that it would launch a rare repo operation “in order to help maintain the federal funds rate within the target range of 2% to 2.25%”.

It said the operation would be conducted with an aggregate amount of up to $75bn.

News of the Fed ’ s intervention sent the repo rate tumbling back towards zero.

Repos are a way for borrowers to raise short-term funding by agreeing to buy and sell securities over very short time frames.

WHEN THINGS LIKE THIS HAPPEN IT INCREASES THE UNCERTAINTY AND LEAVES FIXED-INCOME MARKETS JITTERY

In practice, repos function as short-term loans and are a vital lubricant of the financial system. Banks have become increasingly active in the repo market, lending out some of the surplus money they hold at the Fed to earn a little extra return in a safe and liquid way.

Analysts said there were technical factors squeezing the repo market rather than the systemic issues that drove overnight rates much higher during the financial crisis.

They said that the market had been negatively affected by corporations pulling cash out of the market to pay taxes.

Ashish Shah, co-chief investment officer for fixed income at Goldman Sachs Asset Management, described the moves in the repo market as a “big deal ”.

“When things like this happen, it increases the uncertainty and leaves fixedincome markets jittery. And that is the job of central banks to avoid,” he said.

RATES CUT

The dramatic moves came on the first day of a meeting of the Federal Open Market Committee, the central bank ’ s policy-setting panel, in Washington, DC.

The bank is expected to reduce rates by a quarter of a percentage point.

Some analysts noted there was a more structural explanation for the sharp move higher in the repo market.

The Fed has been shrinking the size of its balance sheet, which also reduces the amount of bank reserves held at the Fed, limiting the available cash on hand for short-term payments.

“We think that the culprit is the scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity,” said TD Securities.

“Reserves have been declining since 2014 and we expect them to decline further as Treasury ’ s cash balance increases and currency in circulation grows,” said the investment bank. /