Surge in overnight lending rates adds twist to Fed Day

The Federal Reserve has intervened in the so-called repo market twice this week after a severe imbalance sent overnight borrowing costs surging to a historic peak.

The FT’s Adam Samson and Joe Rennison report:

In a sign of the crunch that has hit the short-term borrowing market, the Fed’s main policy rate, the federal funds rate, has jumped above the central bank’s 2 to 2.25 per cent target. Data released on Wednesday morning showed the rate rose to 2.3 per cent on Tuesday, from 2.25 per cent on Monday and 2.14 per cent at the end of last week.

The New York Fed, which conducts market operations for the central bank, last used its repurchase agreement auction mechanism during the financial crisis.

The sharp rise in overnight lending rates “seems to reflect technical factors, rather than a reassessment of counter-party risk”, said John Higgins, chief markets economist at Capital Economics.

He added: “We think that the US economy will avoid a recession, let alone experience a very deep one like it did then. The upshot is that we expect the Federal Reserve to stop cutting rates sooner than investors are currently anticipating, leading Treasury yields to rise next year.”

Fed rate of 1% ‘could be the new zero’

The Federal Reserve can only go so far in cutting rates while the US economy remains strong, possibly making 1 per cent the “new zero”, according to John Lynch, chief investment strategist at LPL Financial.

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Mr Lynch sees the Fed cutting rates by a quarter point twice more before the end of the year, which would bring the benchmark federal funds rate to a target range of 1.5-1.75 per cent. “Given the U.S. economy’s resilience and the already low policy rate, we do not expect the Fed to take rates much lower than the 1.5% threshold,” he said.

“Indeed, policymakers want to ensure enough wiggle room to adjust rates further when a recession may appear more likely,” Mr Lynch added. “In this scenario, a Fed funds rate of 1% could be the new zero, accompanied by other recession-fighting initiatives, including renewed quantitative easing programs.”

Investors betting on another rate cut

The market is pricing in a quarter-point rate cut by the Fed today, based on the latest figures from CME Group.

The FedWatch Tool, which tracks federal funds futures, shows that investors have placed 70.4 per cent odds on a 25-basis point cut, with zero chance of a larger half-point cut:

One month ago, investors saw 22.3 per cent odds of a 50-basis point cut.

Less than an hour out from the Fed’s decision, US stocks are in the red and Treasuries are rallying

Here’s where the major gauges sit:

☻ S&P 500, down 0.4 per cent. Utilities are the only sector in the black, while energy is worst off, down 0.9 per cent.
☻ Nasdaq Composite, down 0.6 per cent
☻ Dow Jones Industrial Average, down 0.3 per cent

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In bond land, Treasury yields are lower:

☻ 10-year, down 6.7 basis points at 1.7474 per cent
☻ 2-year, down 5.7bp at 1.6799 per cent

The US dollar index is up 0.1 per cent at 98.328.

What to expect from the Federal Reserve today

Welcome to the FT’s live blog of the Federal Reserve’s rate decision.

The Fed appears poised to lower its benchmark interest rate for the second time this year, after cutting rates in July for the first time since the 2008 financial crisis amid trade uncertainty and global economic challenges.

Strategists at JPMorgan believe the Fed’s statement will stick with language saying the policy committee “will act as appropriate to sustain the expansion”, noting that any changes could send the market a hawkish signal.

Investors also will be glued to policymakers’ outlook for the federal funds rate, known as the dot plot, as well as their economic forecasts.

The Fed will publish its statement at 2pm EST, followed by a press conference with chair Jay Powell at 2:30pm EST.

The FT’s Brendan Greeley and Colby Smith have a breakdown of five things to watch today, which you can read here.

And stay tuned to our live blog for continued coverage of the Fed.

Via Financial Times