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Fed preps second explosion of cash with repo market still on edge by Bloomberg

(Bloomberg) – More than a decade had passed since Federal Reserve traders jumped into US money markets to raise money. And they seemed to get the reaction they wanted on Tuesday morning, immediately cutting short-term interest rates that had spiked to as much as 10% and threatening to ramp up everything from government bond trading to corporate and consumer lending. But the move didn't make it It wasn't long. After the end of the trade session, the rates were about to recede, prompting Fed officials to fire another missive late in the day: They would be back Wednesday morning to offer another $ 75 billion in cash to the market. According to Jefferies, the repurchase rate for the night was noted at around 4% for Wednesday morning.

The movements emphasized how deep the structural problems in American money markets have become. Namely, there is often not enough cash available for large Wall Street firms to meet the financing requirements of a market that is trying to absorb record sales of government bonds needed to finance US budget deficits. According to longtime observers, the solution would be for the Fed to continue to raise money in cash.

"The underlying problem is that there is not enough liquidity in the system to satisfy the demand and the job of the central bank should provide such liquidity," said Roberto Perli, a former Fed economist and partner at Cornerstone Macro in Washington. "What the Fed did was just an update."

A pair of catalysts caused the repo liquidity to be squeezed. It was a huge shot of new government debt that settled on the market ̵[ads1]1; and contributed to the dealer's balance – just as cash was sucked out of quarterly tax payments companies had to send to the government. If left unchecked, the escalation in prices could damage the broader economy by addressing corporate and consumer borrowing costs.

The timing couldn't have been worse, with Fed leaders and many key New York employees gathered in Washington for a two-day policy meeting that ends Wednesday. Fed officials are much expected to reduce the target rate by one quarter. But the money market problem threatens to overshadow that as Wall Street is ready to find out what, if anything, the Fed can do to fix the situation for good.

"The increase in repo and other short-term rates is indicative of the reduced amount of balance that financial intermediaries – especially primary dealers – are either willing or able to provide to those looking for short-term financing," said Tony Crescenzi, Market Strategist at Pacific Investment Management Co. and author of a 2007 edition of "Stigum's Money Market," a widely read textbook first published in 1978. "It serves as a reminder of the challenges investors may face in other ways if and when they seek to transfer risk – sell their risk assets – under a risk-off mode. "

This is far from the first volatility in the over $ 2 trillion repo market, but conspicuous moves tend to happen only by quarter or year-end when liquidity sometimes dries up – not in the middle of the month, as it is now. Although set by the week's huge peak, the turmoil has become more pronounced after the 2008 crisis because reforms designed to secure the financial system have driven some banks out of this market. Fewer traders can lead to fast turns by creating an imbalance between supply and demand.

Fed interventions in the repo market, such as those deployed on Tuesday and scheduled on Wednesday, were common for decades before the crisis. Then they stopped when the central bank changed how it adopted the policy by extending the balance sheet and using a target interest rate band.

The tumor seen on Monday and Tuesday does not mean another global financial crisis, although problems with raising funds through repos A decade ago, the Lehman Brothers judged and almost exhausted the global economic system.

But, many experts say, these wild days show that there are not enough reserves – or excess money that banks park at the Fed – in the banking system. This means that traders will have to pay this week to raise these funds, even though bank deposits total more than a billion dollars. That means the Fed may have to grow its balance of $ 3.8 trillion through quantitative easing, or debt purchases that create new reserves.

There are other means. The Fed has considered introducing a new tool, an overnight repo facility, that can be used to reduce the pressure in money markets. And some strategists predict that it could make a new technical fine-tuning to what is called the interest rate on excess reserves on Wednesday, an attempt to bring the markets back in line.

"There was a coincidence of factors that triggered the problems this week," said Darrell Duffie, a Stanford University finance professor who co-authored Repos with Fed employees. "But the fact that it is happening means something at the Fed should be done. In order for the Fed to be confident of ending the issues, they need to balance."

The US government has done worse over the past year by adding to a record amount of new debt, and that is likely to increase only as the deficit swims over a trillion dollars, bolstering the amount of debt traders have on the balance sheet, and the repo market is a way to fund these positions. their treasuries are down from the top in May, so it's not necessarily behind this week's big move.

"The supply is a background contributor to the problems, since there is only so much more security that needs to be funded," said Seth Carpenter, a former adviser to the Fed Board of Governors, who now heads the United States economist at UBS Securities LLC. – The market is still trying to handle tight balances from dealers. Overall, this is part of the market that is changing over time to a new set of realities. ”

(Adds Wednesday's quote on offer rate in the third paragraph)

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