The Federal Reserve plans to pour cash into the U.S. banking system through early October in a bid to avert another market disruption, but analysts see the need for the central bank to come up with longer-term fixes.
Earlier this week, interest rates in the repurchase agreement, or repo, market soared to levels not seen since the height of the global credit crisis in 2008.
Banks and Wall Street rely on this US$2.2-trillion market for daily cash to fund their loans and trades in other markets, including stocks and bonds.
Repo rates hit 10 per cent on Tuesday, propelling other short-term rates sharply higher.
Analysts blamed huge cash demand to pay for quarterly corporate taxes and the prior week’s US$78-billion worth of coupon-bearing Treasury supply for the market ruction.
They also attributed the decline of excess reserves, to about US$1.4-trillion from US$2.3-trillion in 2017, to the Fed’s reduction of its bond holdings.
The Fed jumped into action early on Tuesday, adding temporary cash on a large scale for the first time in more than a decade to calm jittery markets.
“The Fed is simply acting as lender to banks in order to provide a backstop for them to fund securities, thereby helping balance the supply-demand mismatch which has driven elevated repo rates,” KBW analysts wrote in a research note.
Since Tuesday, the Fed has held four rounds of repo operations, with banks and dealers borrowing from the central banks with their Treasuries and other bonds as collateral.
On Friday, the New York Fed, which implements the central bank’s market actions, said it will conduct more repo operations into October.
This move was on top of the Fed cutting the interest it pays banks on reserves and reverse repos on Wednesday.
What alarmed the Fed on Tuesday, some analysts say, unlike recent episodes when repo rates spiked, was that there was a strong indication the borrowing cost in the federal-funds market was rising above the top end of the central bank’s target range, which was 2.00 per cent to 2.25 per cent at the time.
The Fed targets the federal-funds rate to conduct monetary policy.
If this condition were to persist, it could stoke fears in markets that policymakers are losing control of short-term interest rates, analysts said.
While repo operations are expected to provide a temporary patch, analysts said the Fed needs to offer more permanent solutions.
“The underlying conditions that gave rise to the funding stress are still in place,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.
Other analysts said policy-makers should consider launching a standing repo facility and/or increasing purchases of Treasuries.