The Federal Reserve will extend its cash injections into overnight lending markets for at least another month, after pumping in more than $330 billion since mid-September, as banks face a wave of Treasury bond sales this week amid a near-record budget deficit and ongoing concern over the strength of the world's biggest economy.
The New York Fed said Friday it will extend its overnight repo operations until at least November 4, after earlier signalling they could end on October 10, as part of its broader effort to ease funding conditions in overnight lending markets and bring costs closer to its new Fed Funds target rate of 1.75% to 2.0%. A series of eight "term-repos", or lending operations that inject cash for longer periods of time, will also be conducted between now and November 4.
"While the Fed was ultimately able to stabilize repo dollar funding rates through ad-hoc funding infusions, further repo market volatility could exacerbate global liquidity issues, potentially extending to other asset classes and players beyond the U.S. repo market," Fitch Ratings said in a report late last week.
"Thus far, the effects of the recent repo pricing volatility appear de minimis to these U.S. borrowers," Fitch added. "However, continued illiquidity issues leading to higher or more volatile borrowing costs would be viewed negatively from a credit perspective and could lead to ramifications more globally."
Since September 17, the Fed has conducted dozens of overnight repo operations, in which the central bank offers cash in exchange for eligible collateral such as Treasury bonds and mortgage-backed securities, from the twenty four so-called primary dealers in its banking system.
The $2.2 trillion repo market, a key source of day-to-day financing on Wall Street, was rocked by a massive spike in overnight borrowing costs -- which spiked to 10% on the same day the Fed stepped in with its mid-September operation -- linked to a series of events, including quarterly tax remittances, which drained money market funds, and record Treasury bond issuance.
In fact, primary dealers in the Fed system are taking down nearly $45 billion each day in gross U.S. Treasury bond issuance, and reducing spare cash -- known as excess reserves -- at the same time. Those reserves have fallen by $171 billion so far this year, according to Fed data, and are down $1.4 trillion from peak 2014 levels.
Dealers have been given little respite from the tsunami of fresh Treasury auctions since then, however, and will be forced to take down some $193 billion in paper this week alone, including $108 billion in new debt, as the government funds its near-record deficit of $1.067 trillion.
Federal Reserve Chairman Jerome Powell addressed the repo market challenge during his post rate-decision press conference last month, noting the impact of tax payments and bond purchases on the system's primary dealers was "stronger than we expected ... and surprised market participants a lot too."
He also hinted at a move towards adding to the Fed's $3.8 trillion balance sheet with more bond purchases in order to smooth bank lending conditions as the Fed lowered the rate it will pay on overnight reserves by 0.3%, to 1.8%, in an effort to entice more bank-to-bank lending.