The New York branch of the U.S. Federal Reserve will step in and offer billions more in liquidity to gummed-up intrabank lending markets Wednesday, following the first intervention in more than a decade only yesterday, as a worrying spike in overnight borrowing costs continues to perplex investors and complicate today’s Fed rate decision.
The New York Fed will offer as much $75 billion in cash to broader markets, in exchange for eligible collateral such as U.S. Treasury bonds or mortgage-backed securities, in order to hold the Fed’s key rate inside its target range of between 2% and 2.25%.
The New York Fed was forced yesterday to inject $53.2 billion after overnight borrowing costs surged close to 10%, thanks in part to the hefty burden of primary dealers in the Fed system 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. In fact, excess reserves have fallen by $171 billion so far this year, according to Fed data, and are down $1.4 trillion from 2014 levels.
Nonetheless, the repeat overnight repo operation later today — only the second in ten years — will add to market jitters as to what Powell and his colleagues are likely to say about future rate hikes, and the unwinding of the Fed’s $3.8 trillion balance sheet, in the months ahead.
“We think that the culprit is the scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity,” said TD Securities head of global rate strategy Priya Misra. “Reserves have been declining since 2014 and we expect them to decline further as Treasury’s cash balance increases and currency in circulation grows.”
The New York Fed held an overnight repurchasing operation for the second time this week on Wednesday morning. The U.S. central bank carried out the full $75 billion of repos, temporarily buying securities from Wall Street dealers to inject liquidity into the system. Earlier this week, a surge in the repurchasing rate, used by hedge funds and banks to fund their trading operations, pushed the fed funds rate close to the top of its targeted range. The incident stirred worries that the central bank is at risk of losing its grip over its benchmark interest rate.
Borrowing rates skyrocketed on Tuesday in a corner of the markets the public rarely notices but that is critical to the functioning of the global financial system.
The spike in overnight borrowing rates forced the New York Federal Reserve to come to the rescue with a special operation aimed at easing stress in financial markets.
It was the NY Fed’s first such rescue operation in a decade, the last occurring in late 2008.
“It’s unprecedented, at least in the post-crisis era,” said Mark Cabana, rates strategist at Bank of America Merrill Lynch.
On Tuesday morning, the NY Fed launched what’s called an “overnight repo operation,” during which the central bank attempts to ease pressure in markets by purchasing Treasurys and other securities. The goal is to pump money into the system to keep borrowing costs from creeping above the Fed’s target range .