NY Fed's rescue works. But that has not fixed the market

But the cash crisis has only subsided because of all the free money pumped in by the Fed. Without cash injections in case of emergency, the stress would probably return. Although the NY Fed rescue works, it has not solved the underlying problem.

"There is still a lot of caution and nervousness among many traders and clients," said Mark Cabana, pricing strategist at Merrill Lynch Bank of America. "The neighborhood is a test."

Broken Plumbing

Normally, Wall Street pays very little attention to the lending markets overnight. But it's not because they don't matter. Overnight lending markets are like plumbing in US capital markets. They allow banks, hedge funds and other financial institutions to borrow money quickly and cheaply for short periods.

Investors were surprised to hear last week that the plumbing work was broken. The rate of repurchase or repurchase agreements overnight increased to 5% on September 1[ads1]6. That is more than double the target for short-term loans set by the Federal Reserve.

Such a peak is alarming because it signaled stresses in the market at a time of relative calm. What would happen during the turbulence in the market? And sustained pressure could cause investors to fear that the Fed will no longer have control over short-term borrowing rates.

The stress worsened the following day, when interest rates rose as high as 10%. The NY Fed responded by pumping $ 53 billion into the system through what is known as an "overnight repo operation." These cash injections, which are quickly repaid, aimed to get borrowing costs to come back in step.

Borrowing costs fell immediately, but the Fed realized that more help was needed. The NY Fed pumped in $ 75 billion over each of the last three days of last week.

Clamor for cash

[19659003] But these operations drew strong demand, suggesting that the Fed could not go away. And then the Fed announced last Friday that they would continue to pump in cash every weekday until October 10. As for the end-of-quarter concerns, the Fed also announced three repo operations, each with a 14-day period.

The music on Wall Street for Fed Cash has persisted. Tuesday's 14-day repo operation drew $ 62 billion in demand. That's more than twice what the NY Fed gave.

"That says the Fed doesn't provide enough liquidity," said Bank of America & # 39; s Cabana.

In other words, there is just not enough cash in the financial system.

The strong demand can also only show that Wall Street companies are being cautious by making sure they take advantage of the cash on offer.

"If heaven forbid that something went wrong and you weren't trying to get money from the Fed, you'd be fired," said Seth Carpenter, an economist at UBS.

& # 39; False explanations & # 39;

In any case, the market signals that the Fed should not shut down the cash injections yet. And the continued need for liquidity casts doubt on some of the early theories of market stress.

Last week, Fed Chief Jerome Powell supported the idea that the turmoil was driven by two one-off factors: withdrawing cash from US companies to make quarterly tax payments to the Treasury Department and settling a large amount of government purchases.

"These events are in the rearview mirror, so what happens now?" asked Nicholas Colas, co-founder of DataTrek Research. "There have been so many crazy explanations."

Others have blamed rules after the crisis that limit banks' ability to provide liquidity when needed.

The Fed's inability to explain the market stress suggests that they are still trying to make sense of it themselves. Officials struggle to figure out how much money is needed in the system to make it work smoothly.

"If they knew what the funding needs were, last week would never have happened," Bianco said. "They don't want to look like they're fluttering around and doing it together."

& # 39; Just a blip & # 39; or something more?

The markets may not return to normal until the Fed comes up with a long-term solution, said Peter Boockvar, chief of investment managers at Bleakley Advisory Group.

"We want these daily fires to go out," Boockvar said. [19659013] Analysts said that the Fed is likely to prevent future liquidity pressures by either creating a standing repo facility or agreeing to increase the size of the balance again.