Federal Reserve Chairman Jerome Powell says short-term interest rates are back under control. Not everyone’s convinced.
There’s evidence traders expect pressure to build in the weeks ahead. Brokers on Thursday are quoting repurchase-agreement rates for year-end around 3.25%, or roughly one-and-a-half percentage points higher than today’s levels, and they’ve mostly been above 3% for months. That’s even after Powell’s attempt to reassure markets on Wednesday and the central bank’s announcement Thursday of its latest round of liquidity injections, some of which will span the end of the year.
The central bank has been injecting liquidity into the funding markets since Sept. 17, when the rate on overnight general collateral repo jumped to 10% from around 2%. The Fed also started buying Treasury bills last month to add reserves into the system. These efforts have mostly calmed repo rates. But many are yearning for more fundamental adjustments to how the market works.
Almost two months after the chaos, “the Fed has used a Band-Aid to ensure the money markets don’t seize up and spike again,” said Mark Cabana, head of U.S. interest rates strategy at Bank of America Corp. “The short-term fix is in, but the longer-term plan remains very unclear.”
Market participants next week will parse the release of the minutes from the Oct. 29-30 Federal Open Market Committee meeting for more detail about potential long-term fixes for the funding markets. At the same time, they’ll be keeping a close eye on the central bank’s ongoing repo operations, T-bill purchases, as well as looking ahead to key crunch dates.
Speaking to members of the U.S. Congress Wednesday, Powell discussed the mid-September turmoil, saying the Fed has contained the strains within the repo market.
“I think we have it under control,” he said. “We’re prepared to continue to learn and adjust, but it’s a process and it’s one that doesn’t have implications for the economy or general public.”
He said in further testimony Thursday that the repo chaos might have been caused by bank reserves getting too scarce two months ago. But he also addressed the possibility — something raised recently by JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon — that regulations clogged the plumbing, preventing banks from moving money around.
There are aspects of regulations that could be adjusted to allow liquidity “to flow more freely in the system without undermining safety and soundness,” Powell said.
Rules passed after the 2008 financial crisis were designed to ensure banks had ample liquidity if a market shock made them unable or unwilling to lend to each other. Senator Elizabeth Warren, a Democratic front-runner to challenge Donald Trump in the 2020 election, recently warned Treasury Secretary Steven Mnuchin not to tinker with these requirements — which include so-called liquidity coverage ratios — since they’re meant to prevent catastrophes.
But on Oct. 30, Powell brought up one possibility that would be an alternative to lowering capital and liquidity requirements: letting banks run “daylight overdrafts” in their Fed accounts — meaning they could have gaps between payments and settlements during the day as long as they closed them by the close of business.
FTN Capital Markets strategist Jim Vogel said the next test for the money markets will be appetite for the Fed’s term repo offering that bridges the U.S. Thanksgiving holiday and month-end.
The New York Fed announced plans Thursday to conduct repo operations within the coming month that have longer terms than those it has done previously. It will conduct two operations each with terms of 42 days, according to its website. One of these will have a maximum size of at least $25 billion and the other $15 billion. The bank is also planning a $15 billion, 28-day operation as well as a series of actions with terms of 13, 14 and 15 days, tenors it has used previously.
The decision to implement some operations with longer terms will allow some funding to carry past the turn of the year, though Bank of America’s Cabana is skeptical this will be enough to sate the funding market.
“This is not a ‘whatever-it-takes’ type of announcement,” he said. “It is a ‘let’s-see-how-it-goes’ type of announcement. That risks seeing additional funding pressures toward year-end.”
Financial institutions are starting to retreat from repo to shore up year-end balance sheets for regulatory purposes, while the market also has to contend with another quarterly corporate tax payment and Treasury coupon auction settlements on Dec. 16. The regulatory pullback is why Cabana is still concerned about late December.
“We should know if the funding market is going to come under more material pressure in the next two to three weeks,” he said.