Fed pumps more cash as key rate breaks above target

September 19, 2019 07:41
Dollar money markets have wobbled this week as banks and Wall Street dealers scrambled to find daily funding for their trades and loans. Photo: Reuters

The Federal Reserve injected another US$75 billion into the US banking system on Wednesday, restoring a measure of order after a bout of extreme volatility inside the bank funding market drove the central bank’s benchmark interest rate above its targeted range for the first time since the financial crisis, Reuters reports.

The ructions in the money market come as Fed policymakers met and cut interest rates again on Wednesday to combat risks from US-China trade tensions, a slowing global economy and sluggish domestic inflation.

This puts pressure on Fed officials to come up with long-term fixes – such as a standing repo facility and cutting interest on what they pay on excess reserves (IOER) and growing its balance sheet – to avert further volatility in funding markets and to add more permanent reserves into the banking system, analysts said.

On Wednesday, the Fed lowered the interest it pays on IOER by 30 basis points, to 1.80 percent.

On Tuesday, the “effective” or average interest rate in the federal funds market, which the Fed aims to influence, hit 2.30 percent, above the top-end of the Fed’s current range of 2.25 percent.

Such a move, which has not happened since 2008, if it persists, would rattle investor confidence in the Fed.

“It gives the impression, or confirms some of the market’s fears that the Fed is not in control of its target policy rate because it has lost control of money market liquidity,” said Gaurav Saroliya, director of macro strategy at Oxford Economics.

“In that respect, it can be a confidence-sapping development unless they get it under control relatively quickly,” he said.

The New York Federal Reserve said it will conduct a repurchase agreement operation early Thursday “to help maintain the federal funds rate within the target range of” 1.75 percent to 2.00 percent.

Not alarming yet

Concerns over problems in money markets spreading have been muted so far.

“I don’t believe it is a signal of concern, I think it is an aberration,” said Ken Polcari, managing principal at Butcher Joseph Asset Management.

Dollar money markets have wobbled this week as banks and Wall Street dealers scrambled to find daily funding for their trades and loans.

Analysts have blamed quarterly corporate tax payments and settlement on US$78 billion in coupon-bearing Treasury securities on Monday for a severe drop in cash for wholesale lending.

These factors sent borrowing costs in the US$2.2 trillion repurchase agreement (repo) market soaring to 10 percent at one point on Tuesday, about four times the Fed’s policy rate.

“The question really becomes how is the Fed going to make sure we don’t have this volatility in the repo markets,” said Subadra Rajappa, head of US rates strategy at Societe Generale in New York.

Fed acts

With evidence that market distress would push the federal funds rate above its target early Tuesday, the Fed deployed a maneuver it had not used since the credit crunch to add liquidity into the bank system.

“This is what caused them to jump into action,” said Lou Crandall, chief economist at Wrightson ICAP LLC.

The New York Federal Reserve, which conducts open market operations for the Fed system, held an overnight repo operation on Tuesday, resulting in a US$52.15 billion cash infusion into the banking system.

In an overnight repo operation, banks borrow cash from the Fed using Treasuries and other securities as collateral.

Another repo operation on Wednesday injected US$75 billion.

These operations have reduced repo rates, which were last quoted at 2.10 percent to 2.25 percent midday Wednesday.

They also seemed to lower the rates in other money market instruments such as Treasury bills.

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