Jerome Powell, Chairman of the Board of Governors of the US Central Bank, awaits the start of a hearing on the House Financial Services Committee in Washington, D.C., Wednesday, July 10, 2019.
Andrew Harrer | Bloomberg | Getty Images
While the Fed met to consider cutting interest rates, it lost control of the reference rate itself that it manages.
There has been a rough week in the overnight financial market, with interest rates temporarily reaching as high as 9 and 1
The strange rise in interest rates forced the Fed to jump in with money market operations aimed at reinserting them, and after the second operation Wednesday morning, it seemed to have calmed the market.
In a rare move, the Fed's own benchmark for funded funds rose to 2.3% on Tuesday, above the target range set when it cut interest rates at its last meeting in July. The target range is 2 to 2.25% and the fund price was at 2.25% on Monday.
Another rate the Fed is looking at, the secured overnight funding rate or SOFR shot up 5.25% Tuesday from 2.43%. It's the median interest rate of $ 1.2 trillion in short-term financing transactions that happened on Tuesday. SOFR affects floating interest rates of around $ 285 billion in outstanding corporate and other loans.
Fed Chairman Jerome Powell is expected to question the matter as he briefs the press, following the Fed's 2 p.m. rate decision Wednesday afternoon. The Fed is expected to cut its target interest rate on injected funds by a quarter to 1.75 to 2% later.
"This just doesn't look good. You set your goal. You're the mighty Fed. You're supposed to control it, and you can't on Fed Day. It looks bad. This has been a tough race for Powell, "said Michael Schumacher, director at Wells Fargo.
Schumacher and other strategists said the Fed's two operations on Tuesday and Wednesday appear to have calmed the market for now, but the question is why did it happen to fluctuate in prices in the first place. Strategists say it appears to be the result of a cash crunch, not. A credit crisis has been made for the time being.
What is repo?
But the concern is that if it persists, it may indicate an underlying problem in the financial system. Strategists link the problem to a number of factors, including the Fed's reduction in its own balance sheet which removed some liquidity from the market, as well as changes in rules following the financial crisis that required banks to have more capital, reducing their ability to offer repo. Repo is an exchange of securities, such as government securities, for cash.
Monday seems to have been a perfect storm in the market, causing cash shortages. Companies sought dollars for quarterly tax payments, and the Treasury had also issued a large amount of bills, reducing liquidity. There were also speculations that the attack on Saudi Aramco, which took half the production off the line, may have spurred demand as oil spiked and investors feared a conflict in the Middle East.
The Fed on Tuesday accepted $ 75 billion of $ 80.5 billion in bids delivered to its overnight repo operation, after accepting $ 53 billion on Monday. The repo rate was listed at 2.25 to 2.60% after Tuesday's operation from an area up to above 3%, just before that. This rate on Tuesday temporarily hit a high of 9%.
"They are working on this repo problem. It is a work in progress. They are doing very well. They have it quite under control," said Ralph Axel, a strategist at Bank of America Merrill Lynch.
Strategists said the Fed is likely to trim interest on surplus reserves at its meeting Wednesday. That rate is currently 2.10%, and Schumacher said it can cut the Fed to 1.80% when it cuts prices on Wednesday. It can help the Fed keep better control of the funds raised.
"Generally, the whole repo spike is dropping. So you can expect that fed funds will likely hit a bit lower tomorrow, but it might not be enough to be in the band," Axel said.
Fed must contact Wednesday
Axel said the market will look for answers from the Fed on how it will solve the problem permanently, especially with the approach to the end of the quarter September 30, when there is more funding pressure as alternative financing usually is reduced by the end of the quarter and the repo is in high demand.
"Will the Fed continue to roll over the $ 75 billion plant for the rest of the month? Or will it go into permanent operation?" said Axel. "September 30 is another potential hot spot for funding rates. It's a big question to make sure they check prices on September 30 to make sure they stay within their band,"
The Treasury Department moved to coast up own cash reserves, which went from $ 183 billion a week ago on Wednesday to $ 298 billion on Monday.
"Since the debt crisis in 2011, Treasury has decided to maintain a very large cash balance," Axel said, adding the Treasury previously found it not necessary. He said that the Treasury decided it was in the public interest to have a large cash balance to absorb any problems in the financing market.
Axel said that the funds are taken from surplus reserves that the Fed controls, and that it reduces the money supply. "That's the reason to offset this, and to solve the problems that were in the financial markets, the Fed put money into the money through open market operations, which is the traditional role New York feeds," he said.