US Federal Reserve uses repo market to boost market liquidity

Global Business

US Federal Reserve uses repo market to boost market liquidity

With the Federal Reserve looks set to cut its benchmark interest rate by another quarter percent, markets are trying to figure out where the U.S. central bank is headed.

It’s been ratcheting up rates for three years. This year it reversed course. While Chairman Jerome Powell called it a “midcycle adjustment,” there’s something happening in an obscure, but critical corner of the financial market, which could mean more rate cuts ahead.

CGTN’s Toni Waterman explains from Washington.

It all started in mid-September when stresses sprung up in the repo market. This is the place banks and financial institutions go to borrow money from each other, often on an overnight basis.

Suddenly there were more borrowers than lenders, credit tightened, interest rates spiked.

The Fed was forced to step in-injecting billions of dollars to calm the market.

“The problem is, since mid-September, the problem has been growing and growing,” James Bianco, President & Macro Strategist of Bianco Research said.

“We’re north of $220 billion that the Fed has been supplying to the repo market to keep it calm.”

It’s still unclear why cash flows got tighter. Some point to the Fed’s attempts to shrink its own balance sheet while others blame post-crisis banking regulations, which require lenders to keep more cash in reserve.

For now, though, there’s little evidence the volatility is foreshadowing an impending crisis the way a sudden tightening in the repo market did in 2007.

“What it does foreshadow, though, is that the Treasury market has changed, David Wessel the Senior Fellow & Director at The Hutchins Center on Fiscal and Monetary Policy at the Brookings Institute said.

“The government is selling a lot of debt, because it’s running such a large budget deficit, foreign buyers like the Chinese aren’t buying quite as much. We are having some frictions that if we don’t solve, we could have repeated episodes like this.”

The Fed is trying to separate what’s happening in the repo market from monetary policy. When it announced it would expand its balance sheet, again, through Treasury bill purchases it insisted this wasn’t another round of quantitative easing leaving many confused.

“I suppose they’re kind of related,” Wessel said. “But I think they’re trying very hard to say we’re trying to fix the plumbing issue without changing monetary policy.”

That may be the intention, but some experts are skeptical that the Fed’s intervention in the repo market won’t be a substitute for future easing.

“They can announce they’re going to cut rates. That’s easy to understand,” Bianco said. “Or they can keep buying at 3-month Treasury bills rates which repo, short-term funding and adjustable-rate point mortgages are all tied to. Those rates can keep falling, because the Fed is buying. That is a rate cut. They can pretend it’s not, but it is.”

Meaning that easing could continue even if the Fed signals an end to this latest round of rate cuts.