The Fed fix of the repo market will be put to the test on Monday, when the third quarter ends

The Federal Reserve has used open market operations to calm the short-term funding market, and now the interim scheme is facing a test when the third quarter ends.

The Fed has used night and 14-day market operations to stabilize the repo market, used by financial institutions to finance itself in the short term. The Fed reacted to a sudden rise in interest rates on September 16 and 17, and it is under pressure to resolve the problem permanently, which appears to stem from an overnight cash crisis in the loan market, rather than a credit crisis.

During the temporary panic in the overnight fund market, interest rates rose to as high as 10%, and the Fed's own federal benchmark rates traded briefly to 2.30%, 0.05 above the Fed's target range on September 1[ads1]7. in the Fed's operation was at a subdued 1.80% Friday. Over the past few days, the Fed expanded its facilities as they met high demand, but by Friday, both the $ 100 billion dollar repo overnight and $ 60 billion in 14 days were signed.

"Obviously things are quieter than they were last week, but there are still clear questions and concerns. We still have relatively high rates whether in Treasury's or mortgage loans [this week]" said Ralph Axel, US exchange rate strategist at Bank of America Merrill Lynch. "There is still debate whether adding additional reserves at this time or not will be important for funding issues through the end of the year."

Repo is a corner of financial markets that is unclear to most people. This is where institutions go when they need short-term cash and exchange some collateral, like Treasury's or mortgage, for a short-term loan. It's considered the plumbing of Wall Street, and the worry is that if it doesn't work or show stress, it can lead to real stress in the financial system.

The third quarter winds down on Monday, and overnight, as is known, the repo market may face strong demand as banks withdraw loans to spruce up the balance to end the quarter. The pros in the market will see how much the Fed system is used and whether interest rates will be raised again. There should also be high demands due to cash needs related to the $ 113 billion settlement in Treasurys, auctioned Tuesday, Wednesday and Thursday.

"If things get messy, the Fed will look it up … If the Fed gets this worked up by the end of Q3, it looks like the Fed will take aggressive measures to make sure the year-end is in order," says Michael Schumacher, director, rate strategy at Wells Fargo. High repo returns make it difficult for borrowers to maintain the type of margins they need for certain types of investments. Hedge Fund is a customer for the repo market. "They need repos … if the repo gets tougher to get more expensive, it makes it harder for a hedge fund to get a position."

Major banks that are primary traders are the only institutions that can use the Fed facility, and they will then lend to other institutions that need capital. but they can also serve as a bottleneck since they are not required to report how the short-term funds are used.

"Banks are doing a lot of work to make the balances look especially safe when publishing their quarterly statements. That means they will not show a tremendous amount of short-term liabilities in the balance sheet. It's a normal end to quarterly phenomena," he said. banking analyst Odeon Capital Group Richard Bove.

There was also a major improvement on another key rate, the overnight secured rate. The SOFR was 1.85% on Thursday, down from 5.25% on September 17 and 2.01% on Wednesday. This means that on September 17, the 5.25% median interest rate was $ 1.2 trillion in short-term financing transactions. SOFR affects floating interest rates of about $ 285 billion in outstanding corporate and other loans.

Bove said it seems that the problems in the market may have been seasonal, but for some reason demand and supply were unbalanced, and it is still not clear why there was such a high demand for cash. This has led to calls by the Fed to address the situation, which emerged unexpectedly in mid-September, not at the end of the quarter or during a period of financial market volatility. There have been other short periods of stress, especially in December last year when there was a violent sale in the stock market.

"There has always been this problem between the Fed's monetary policy and the Fed's banking supervision policy. Banks' supervisory policy since 2012 has been quite clear on the repos," Bove said. "The Fed did not want banks to be involved in that market. It set rules … what the rules did was to force banks to extend the maturity of the debt and reduce the amount of funds they make available in the repo market." in less support from banks than before.

Strategists said the law changes are part of the problem. The bank's repo business is now showing itself against the capital ratio and may affect the amount of capital versus leverage that the regulators expect to have. In the fourth quarter, this becomes particularly acute as the banks seek to improve final capital ratios.

The Fed changed its rules when the Dodd Frank banking reform legislation was passed after the financial crisis, which was the last time the Fed had to intervene in the repo market.

The Fed is expected to address the problem of the cash crisis when it meets on October 29 and 30, and it should discuss some of the solutions it has previously considered, such as a standing repo facility where it would be prepared to intervene every day. Another solution would be to expand the balance sheet, and the conversation is that it will consider some short-term quantitative easing to expand Treasury's portfolio.

The New York Fed is conducting market operations for the Federal Open Market Committee, and it could stabilize the market when it began operations on September 17. Strategists say Monday's outcome will be important to see to see how much demand there is for capital, plus the rate at which it is accepted. A sharp rise in prices would be a warning that the Fed needs to keep its hands on the market into the fourth quarter as it is working towards a long-term solution.

"I think it will go well because the New York Fed has an eye on the matter. I'm not worried," said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics. "I don't want to exaggerate the problem, as long as they answer, they can keep it under control … Our point is that they have a system in place that is more automatic, so these problems don't come back and they don't have to continue to respond. The most important thing is a standing repo facility where people who want to borrow can borrow at a rate that the Fed sets … They should also increase reserves and balance. "

, the spike blames last week on a perfect storm of events. There was a sharp increase in demand from companies that made tax payments as well as investors who had to settle for a large amount of Treasurys. But an unexpected incident was the attack on Saudi Aramco, which knocked out half of its energy production. It is believed to have prompted some investors to seek cash security, and it also sparked speculation that Saudi Arabia itself was seeking cash, as a temporary advance regulation.

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