The Eccles Building, location of the Board of Governors of the Federal Reserve System and of the Federal Open Market Committee
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The Fed’s management of the short-term funding market passed a crucial test Monday, but the central bank is still under pressure to create a long-term fix for the market that funds financial firms’ short-term cash needs.
The Fed stepped in to intervene in the repo market, after a wild spike in short-term rates to about 10% on Sept. 15, as the system faced a cash crunch. A repo, short for repurchase agreement, is an exchange of collateral, such as Treasury securities, for cash.
“They’ve just pounded the funding markets with liquidity and it seems to have put the fire out,” said Ward McCarthy, chief financial economist at Jefferies.
The Fed announced a series of operations to help the market over the last two weeks, and traders were paying close attention to Monday’s operation since it would signal if the market was under control. The Fed ramped up its operations, ahead of Monday, as the end of the quarter loomed. Typically at quarter end, there’s pressure for cash, but banks also step back from some of the short-term lending they do so they can spruce up their balance sheets.
The Fed’s $100 billion overnight repo facility ended up being underscribed Monday morning, meaning there weren’t as many bids as the cash offered, and the Fed accepted $63.5 billion in Treasury and mortgage securities. But interest rates were slightly elevated. The weighted average rate for Treasurys in the Fed’s operation was 1.89%, above Friday’s level, but the high end of the range was at 2.25%, the highest since Sept. 18.
Aside from the Fed’s operation, the private market general collateral repo rate for Treasurys rose to 2.5%/2.7% at the open, but then traded lower. That is above the rate of 1.75% to 2% that the Fed has targeted for its fed funds rate range. The Treasury repo rate on Friday was around 1.90% at the open in the private market.
“The jump in rates is expected on quarter end-days. This one is OK. What happened two weeks ago was not good,” said Jon Hill, rate strategist at BMO.
“Rates were a bit elevated but it wasn’t the blowout rate we saw,” Hill said.
Hill said the next date to watch is Oct. 15, when there is another big Treasury settlement. That was one factor blamed for the crunch on Sept. 15. The other factor that day was that it was a tax pre-payment date and corporations were looking for short-term cash.
The repo market has seen several moments of stress recently, including in December when stocks were selling off sharply. But not until this month has the Fed had to intervene since the financial crisis.
The Fed should address the situation at its next meeting Oct. 29-30. The Fed is expected to keep its daily operation in place and turn it into a longer-term solution. The Fed may also look to expand its balance sheet, and some market pros expect it to buy securities in the market in an operation resembling quantitative easing.
