Fed squeezes liquidity into system as it tries to regain control of rates

The Federal Reserve rushed to inject liquidity into the financial system on Tuesday and Wednesday as it tries to wrestle control over interest rates.
Over the past two days, borrowing costs surged as market participants scrambled for funding, pushing the effective federal funds rate to 2.30% as of Tuesday night, above the Fed’s target range of 2.00% to 2.25%. In focus: the repurchase agreement (or repo) market, where banks and Wall Street dealers lend to one another overnight to meet day-to-day financing needs.

A lack of available bank reserves to support the interbank lending have led to higher interest rates. The New York Fed stepped in on Tuesday morning, overcoming technical difficulties to offer the first repo program of substantial size since 2008.

“Sustained [federal funds] pressure will likely raise questions about the Fed’s ability to control money markets, especially as federal funds approach the upper end of the Fed’s target range,” Bank of America Merrill Lynch wrote Tuesday morning, when the effective interest rate was right at 2.25%.

But others said concerns over Fed credibility may be overblown, as the spike in interest rates appears to be the result of a temporary flurry of financing needs associated with the timing of corporate tax payments and Treasury auctions.

U.S. Federal Reserve Chairman Jerome Powell speaks during the “The Economic Outlook and Monetary Policy” panel discussion hosted by the Swiss Institute of International Studies at the University of Zurich in Zurich, Switzerland September 6, 2019.

To address the short-term crunch, the New York Fed’s trading desk announced that it would supply some liquidity by buying up to $75 billion in repurchase agreements, in which the bank buys up Treasury and federal agency debt and sells them back when the repo expires.

The desk originally planned to carry out the operation at 9:30 a.m. ET on Tuesday, but “technical difficulties” delayed the repo program by about 25 minutes.
The auction ended up generating about $53 billion in agreements. On Wednesday morning the New York Fed re-opened its large repo facility (on time) and auctioned the maximum amount of agreements at $75 billion. With funding pressures expected through at least the rest of the month, the Fed could continue to rely on its short-term funding facility to relieve pressures on interest rates.
The wonky episode adds another wrinkle to the Fed’s looming decision on interest rates, as policymakers prepare the next moves on interest rates this afternoon.

Nomura’s Lewis Alexander wrote Wednesday that the repo crunch will nudge the Fed to move “sooner rather than later” and possibly restart growth in the Fed’s balance sheet to support more bank reserves in the system.

Why the spike?
The repo market provides critical short-term cash for dealers to finance Treasuries and other securities, making these overnight loans the “plumbing” of the U.S. financial system.
In the case of spiking repo market rates, borrowers appear to be pressured by corporate tax payments and settlement of newly auctioned U.S. Treasuries. With bank reserves hard to come by, some dealers were paying as much as 10% for repo agreements on Tuesday.

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The Secured Overnight Financing Rate, the Fed’s measure of the cost of overnight borrowing collateralized by Treasuries, skyrocketed from 2.20% on Friday to 5.25% this week.
The liquidity crunch was anticipated by some shops on Wall Street. Bank of America Merrill Lynch had warned that the due date on corporate tax payments would pull $75 billion to $100 billion out of funding markets. All the while, the U.S. government is hoping to fill its Treasury general account (TGA) by funding $155 billion of debt over the course of September.
“The TGA rebuild today represents a large reserve drain and the withdrawal of this cash from money markets ha