Fed curbs repo volatility on final day of 2019
The US Federal Reserve succeeded in keeping a lid on short-term borrowing costs on the final day of the year after injecting billions of dollars into the market to ease a possible cash crunch.
The cost of borrowing cash overnight in the repo market, where investors exchange high-quality collateral such as Treasuries for funding, rose to 1.88 per cent on Tuesday before falling over the first couple of hours of trading to 1.55 per cent.
That is in line with levels seen throughout December and far below the peak level of 6 per cent reached on December 31 2018, according to data from Curvature Securities.
“The market is very calm,” said Mark Cabana, an interest rate strategist at Bank of America Merrill Lynch. “There really hasn’t been any pressure early in the day. I think the Fed has crushed any kind of year-end volatility with all of the operations they have done.”
Investors and analysts had feared a repeat of the spike in September when a scramble for cash pushed repo rates up as high as 10 per cent, alarming some market participants and prompting a series of actions from the Fed.
The markets arm of the central bank went all out to ensure the year-end period went smoothly, injecting $255.6bn to keep money flowing through the financial system. It had said it would offer up to $490bn, depending on demand.
The New York branch of the US central bank, responsible for market operations, provided $25.6bn in overnight funding on December 31, adding to $230bn of longer-term repo operations — in effect short-term loans — that will mature throughout January.
Elevated repo rates are more common at the end of the year, as banks often pull back from lending into the market ahead of important regulatory calculations taken before the start of the new year, leaving less cash available to investors.
Mr Cabana added that the Fed was helped by banks finding new ways to trade with clients outside of traditional repo lending, while still lowering year-end regulatory burdens. For example, Goldman Sachs mimicked repo trades with hedge funds through the derivatives market, in a bid to lower its capital charges.
With the year-end hurdle cleared, investors’ focus has shifted to what comes next for the Fed and how it will go about weaning the market off the money it has provided.
In addition to the overnight and short-term loans the central bank has offered up, it has also expanded its balance sheet by purchasing Treasury bills, which have a maturity of one year or less, in an attempt to further bolster cash in the system.
“The Fed has delivered on its promise to flood the market with liquidity,” said Gennadiy Goldberg, a US rates strategist at TD Securities. “But I highly doubt the Fed will be breaking out the ‘mission accomplished’ banner just yet, as they now have to worry about what they do from here.”