The Federal Reserve has injected billions of dollars into the US financial system to alleviate a dramatic squeeze in the country’s short-term funding market.
The cost of borrowing cash in exchange for US Treasuries overnight using repurchase agreements, known as repos, surged between Monday afternoon and Tuesday morning to as high as 10 per cent, an increase of more than fourfold, Refinitiv data show.
Repos are an important way for borrowers to raise short-term funding by agreeing to buy and sell securities over very short time frames. As such they are a vital lubricant of the financial system.
The sudden tightening of the market caused a predicament for the Fed just as top policymakers were meeting in Washington to make a decision on monetary policy.
The jump in the repo rate cascaded to the federal funds rate, the central bank’s primary monetary policy tool. It dragged the FFR higher to 2.25 per cent, the very top of the range targeted by the Fed’s policy-setting board.
In response, the New York Fed, which conducts market operations for the central bank, said on Tuesday that it would launch a rare operation “in order to help maintain the federal funds rate within the target range”.
The New York Fed made up to $75bn available through a repo auction in which the Fed accepts Treasuries and other securities as collateral, and in exchange, provides cash that lubricates the system.
The New York Fed had to cancel the operation on the first attempt due to “technical issues”. On the second effort, primary dealers — big banks that act as trading counterparties of the Fed — tapped the facility for $53bn.
The operation appears to have succeeded in steadying the money markets. The repo rate tumbled to around zero soon after the Fed announced its manoeuvre.
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 the market had been hit by corporations pulling cash out of the market to pay taxes. A glut of Treasuries, which are used on the other side of the trade, created an imbalance that sent the repo rate soaring higher.
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 fixed income markets jittery. And that is the job of central banks to avoid,” he said.
Some analysts noted 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.”
Additional reporting by Michael Mackenzie