Over the past month or so, the Federal Reserve has been paying a lot of attention to a rollercoaster ride in the short-term financial markets, which has led to major Fed cash infusions via the repurchase agreement, or repo, markets.
To cut to the chase, the Fed efforts are showing positive signs, says Lorie K. Logan, senior vice president and acting head of the markets desk at the New York Fed, who spoke at the Annual Primary Dealer Meeting of the group on Nov. 4.
Yet questions about the cause of the shortages in the repo markets remain.
To recap, a repo “is a form of short-term borrowing for dealers in government securities,” according to the definition from Investopedia. “In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.”
In September, as The Wall Street Journal and other news outlets reported that “short-term financial markets, for a number of reasons, ran short of the money financial firms lend one another to deal with short-term funding needs.”
This shortage spurred a big jump in short-term lending rates, which caused a lot of concern at the Fed. To help resolve the situation, Fed officials have been pumping money into the system in large amounts via repos.
As the WSJ explains it, the Fed “takes in on a short-term basis Treasurys, agency debt and mortgage-backed bonds in exchange for loans of cash to eligible banks. These temporary additions restarted in mid-September for the first time in over a decade, and on some days, they have seen the Fed adding over $100 billion to markets.”
For now, “the repo operations have successfully offset supply changes and money market pressures associated with big anticipated drops in reserves, such as around mid-month and month-end settlements,” Logan says.
The repo measures “have been effective at restoring calm in money markets and maintaining control over the federal funds rate. … Participation in the repo operations has been robust and the transmission to broader money markets has been good,” Logan adds.
At the same time, the situation has the attention of politicians including one running for president.
Democratic presidential candidate Elizabeth Warren, who is also the U.S. Senator for Massachusetts, found time to write to Steven T. Mnuchin, secretary of the U.S. Department of Treasury, in his capacity as chair of the Financial Stability Oversight Council (FSOC) and asked him about “the recent volatility in the short-term lending market, the ‘emergency measure’ … in response to this volatility, and the two extensions announced in response to these efforts in recent weeks.”
The Warren letter, dated Oct. 18, reports that she is “alarmed that it has been required to engage in money market interventions that have not been used since the 2008 financial crisis, and I write to obtain your understanding of the underlying causes of this fluctuation in the market and how you plan to mitigate them.”
Warren sent Mnuchin a long list of questions about the situation and asked for responses by Nov. 1. It’s not clear if Mnuchin responded to the inquiry or ever will.
For now, it seems a convergence of pressures caused the shortage in the funding market, according to a blog posting by Jerome Schneider, head of short-term portfolio management at the Pacific Investment Management Co., or PIMCO, and William Martinez and Jerry Woytash who are portfolio managers on the short-term desk for the mutual fund giant. Their blog, “Repo Rate Spike: A ‘Tail’ Of Low Liquidity,” was published online Sept. 18, 2019.
The trio found that the major contributing factors were:
- “Payments on corporate taxes were due on 15 September, leading to high redemptions of more than $35 billion in money market funds.”
- “Cash balances increased by an additional $83 billion in the U.S. Treasury general account, which reduces excess reserves and simultaneously acts to reduce the aggregate supply of overnight liquidity available in funding markets.”
- And “Dealers needed an additional $20 billion in funding to finance the settlement of recent scheduled U.S. Treasury issuance.”
“None of these pressures was extraordinary or unforeseen, but together they had an extraordinary impact,” according to the blog.
Looking ahead, the NY Fed markets desk will conduct Treasury bill purchases “to maintain a supply of reserves consistent with the [Federal Open Markets Committee] FOMC’s directive to maintain reserves at or above early-September levels. Also, since it will take some time to accumulate securities holdings to achieve that objective, the Desk is continuing to provide reserves temporarily through overnight and term repo operations,” Logan says. “We are monitoring market conditions closely, have tools to effectively and efficiently support monetary policy implementation, and will make adjustments as needed.”
The Fed isn’t the only organization watching the situation closely.