The Federal Reserve signalled that it plans to maintain its interventions in short-term funding markets at an elevated level, even after a year-end cash squeeze passed without any jump in borrowing costs.
The New York arm of the US central bank said on Tuesday that it would only start to cut back its cash injections for the repo market next month, and even then the reduction will be modest.
Traders have been wondering when and how the market will be weaned off central bank loans, which began after a surprising jump in overnight borrowing costs in September and were expanded in size in December before the traditionally volatile end to the year.
The new plan maintains the elevated size of the Fed’s overnight and two-week lending — at up to $120bn and $35bn, respectively — beyond the end of January. On February 4, the central bank will reduce the amount it lends in the form of two-week loans to a maximum of $30bn.
“History has shown us that whenever these sorts of programmes are introduced, they tend to last longer than what the Fed expects,” said Nick Maroutsos, co-head of global bonds at Janus Henderson, noting it took longer than expected for the Fed to begin unwinding its crisis-era quantitative easing programmes.
Earlier on Tuesday, banks gobbled up $82bn in temporary liquidity from the Fed in the form of overnight and two-week repo loans. Bids for the two-week funding were $43.2bn for the $35bn on offer. A similar operation on January 7 was oversubscribed by roughly the same amount, while another two days later was close to fully subscribed.
The repo market is where investors borrow cash for short periods in exchange for high-quality collateral like Treasuries.
Jon Hill, an interest rate strategist at BMO Capital Markets, said he expected the Fed would be slow to pull back and quick to change course if necessary. “If markets are pricing in a sloppy quarter or pricing in fears of a liquidity shortage, the Fed will scale back up repos as needed.”
Lou Crandall, chief economist at Wrightson Icap, called the new schedule published on Tuesday “a token adjustment to indicate the direction of change”, adding: “It shows they are comfortable continuing to provide plenty of repo funding . . . and that they will transition away from this gradually.”
Fed officials have signalled their intention to wind down interventions.
Last week, Richard Clarida, vice-chairman, said “it may be appropriate to gradually transition away from active repo operations this year”, as the Fed increases the amount of money in the system via another means, namely the expansion of its balance sheet through Treasury bill purchases. It has been buying bills at a pace of $60bn a month since October.