The repo market has worsened and the fed’s cheap money is putting it in a bind

The fed may have been caught in the middle of another troubling episode in the us repo market.

The latest data show fresh signs of a funding crunch in the us repo market. Data on Tuesday showed that the New York fed provided financial markets with a combined amount of nearly $100bn in short-term liquidity, including $63.9bn in overnight repo operations and $35bn in 14-day regular repo operations. Of that total, $41.12 billion was received for the 14-day repurchase operation due Jan. 21, the first time since mid-december 2019 that bids for the scheduled repurchase exceeded the fed’s target level of $35 billion.

The surge in overnight repurchase demand suggests that the cash crunch in the repo market has worsened again. But this is strange. It’s been nearly two weeks since the repo market hit its worst cash crunch, so why the cash crunch?

According to the Curvature of the Securities analyst Scott, durkheim (Scott Skyrm), market participants will get cheap money from the fed into other higher-yielding markets.

In his daily repo market review, Skyrm wrote that the fed’s total overnight and long-term repo operations on Friday were higher than at the end of last year. By the end of the year, the fed had pumped $255.95 billion into the market, up from $258.9 billion on Friday.

Skyrm said the us repo market was reflecting a similar problem to that seen over the past decade with quantitative easing and the fed’s balance sheet expansion, in that market participants had become addicted to the easy liquidity unleashed by the fed through its temporary repo operation in September.

As Skyrm writes, the repo market can easily become addicted to easy cash from the fed when the interest rate on the repo operation is 1.55 per cent – below market quotes. As the fed continues to pump cash into the market, market participants have become accustomed to cheap money from the fed.

This is good in the short term because it can drive up the price of risky assets. But in the longer term it is a problem, with money that used to flow back into the repo market now going to other, more profitable markets.

The root of the problem is that the repo rate is at the bottom of the fed funds target range. When the repo rate is high, it is more competitive as an investment than other overnight rates. But now, with repo rates too low, those funds have gone to other markets.

If the situation continues to deteriorate, the consequences may be worse than people think. Just as the market became addicted to quantitative easing, the result was a 20 per cent fall in the s&p at the end of 2018, when markets were panicked by quantitative tightening, the fed’s shrinking balance sheet and declining liquidity. ‘it will be a painful process for market participants to wean the repo market off its reliance on cheap fed funding,’ said Skyrm.

In order for the fed to end its frequent buybacks, they need to get outside money back into the repo market. In addition, for the repo market to attract cash back, the fed needs to let the repo rate rise. So how do you get interest rates to go up? The fed just needs to stop the buybacks. Because the fed restarted repurchase operations last September because the repurchase rate was so high.

That seems simple enough, as long as the fed stops repurchase operations. But the problem is, if the fed to stop repo, would immediately trigger another crisis, the current fed by buying back to the market by the end of the injection of liquidity has been higher than the level, this means that the fed is now by buying back blow a bubble, the federal reserve to buy back the longer the time duration, the more impossible without provoking a volatile market conditions.

Next, Mr Powell may face a difficult choice. Can he continue the buyback policy before the November election? For if the markets had collapsed before the election, and because of the fed’s actions, it would have provoked Mr Trump’s wrath.

Robin Bell

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