Fed pumps extra liquidity into overnight lending markets

The Federal Reserve said on Monday that it will increase the amount of money it is pumping into short-term borrowing markets during the current turmoil, reversing an attempt to wean investors off financing it has been providing since September.

The move comes as nerves grow that market gyrations caused by coronavirus are harming funding conditions for banks and investors. It marks the next phase of the US central bank’s efforts to contain the fallout, following an emergency interest rate cut last week.

The New York arm of the Fed said it would boost the size of its overnight and short-term operations in the repo market “to support smooth functioning of funding markets as market participants implement business resiliency plans in response to the coronavirus”.

The repo market is where investors borrow cash for short periods in exchange for high-quality collateral like Treasuries. The Fed will offer at least $150bn in overnight loans — a $50bn increase from what was originally on offer — until March 12. It will also raise the limit on the amount of cash it will lend into the market over a two-week period from at least $20bn to at least $45bn.

“We have not seen funding markets lock up, but this is the Fed’s way of ensuring that funding markets stay open,” said Gennadiy Goldberg, senior US rates strategist at TD Securities.

The central bank has injected billions of dollars into the repo market since a cash crunch in September sent the cost of borrowing overnight soaring, although it had been gradually scaling back the interventions.

The reversal came after crude prices crashed more than 20 per cent on Monday in response to a price war between Saudi Arabia and Russia that threatens to flood the oil market with supplies just as coronavirus hits demand. The drop in oil sent stock markets plunging and government bond yields to record lows. Corporate bonds have also taken a heavy knock, especially those issued by the most heavily indebted companies.

Since global markets started sinking in late February, investors have clamoured to use the short-term funding on offer from the Fed. Demand has reached more than three times the available funds on offer for most two-week loans, while some overnight operations have also been oversubscribed.

The Fed on Monday said its ramped-up repo operations were aimed at mitigating any risk of money market pressures bubbling up that could adversely affect its ability to implement its monetary policy

Analysts and investors are increasingly nervous that instability in stock markets could become a more fundamental threat to financial conditions.

“If the oil patch bleeds out, that may push us to a situation where coronavirus-related issues feed into one another, and we end up in a dollar funding issue,” said Ernie Tedeschi, policy economist for Evercore ISI. “Any one of those shocks on its own wouldn’t be enough, but maybe both of them together would be.”

The pre-emptive moves give the Fed some “breathing space”, said Jon Hill, a rates strategist at BMO Capital Markets, after the central bank delivered its first emergency rate cut since the global financial crisis last week.

“The shock that is hitting the economy is not a funding shock, and [the Fed’s move] doesn’t avert the coming economic hit, but it removes one more potential problem that could occur this week,” he said. He added that he expected the Fed to continue to increase the size of its operations as needed in order to meet any elevated demand.

“The Fed wants to ensure the market in any way it can that it is ready to act”, he said.

In response to the September cash crunch, the Fed has also expanded its balance sheet by purchasing Treasury bills, which have a maturity of one year or less — an attempt to further bolster cash in the system and ultimately reduce the reliance on the emergency repo operations.

It has purchased T-bills at a pace of $60bn per month, and analysts say they expect the Fed to continue to do so beyond April.