New York (AFP) – For the first time in more than a decade, the US central bank this week entered the financial markets to keep interest rates on short-term lending from skipping its target.
The New York Federal Reserve Bank conducted money market interventions Tuesday and Wednesday, planning another through Thursday morning, as a cash crisis increased the cost of borrowing for banks that need to replenish the reserves they have in the central bank.
Financial institutions use money markets to borrow for very short periods, from one day to a year, a crucial function to keep gears in the economy going.
In so-called repurchase or "repo" agreements, banks lend by setting up assets such as treasuries as collateral and then repaying the loans with interest the following day.
This allows them to replenish the cash holdings they hold in the central bank when the amount falls below the required minimum set by the Fed.
Money market rates typically closely follow the target range set by the Fed for the federal fund rate, the reference lending rate that affects borrowing costs throughout the world economy.
– Why did the New York Fed intervene? –
Money market rates began to jump Monday afternoon and hit as high as 10 percent in some cases, surprising traders.
The reasons for the borrowers' sudden demand for cash were attributed to a number of technical conditions that converged to drain money out of the system.
There were large cash withdrawals when quarterly corporate taxes were due, while a wave of US government debt came into the market to fund deficit spending by the federal government.
More generally, several government securities have built on the balance sheet of private firms these days as the Fed began liquidating its huge holdings of government securities it accumulated during the global financial crisis – which has also sucked money out of the market.
"Looks like a lot of money left the system in the last few days and the demand for dollars was greater than the number of dollars in circulation," said Gregori Volokhine of Meeshaert Financial Services.
To bring down rates, New York Fed pumped fresh liquidity into the system through repo operations – $ 53 billion on Tuesday, $ 75 billion on Wednesday, with another $ 75 billion scheduled for Thursday morning.  – Should We Be Concerned? –
Investors have been wondering if the sudden jump in interest rates was a purely technical error or a sign of a deeper problem in the financial system.
The incident aroused painful memories of the economic downturn in 2008, when credit markets suddenly intervened as banks feared that borrowers would swap before repaying.
But after uncovering fresh cuts to the reference lending rate on Wednesday, US Fed Chairman Jerome Powell told reporters that the liquidity crisis was no problem for the broader economy.
"While these issues are important to the functioning of the market and market participants, they have no implications for the economy or attitude to monetary policy," he said.
Powell noted the deadline for tax payments and increase in debt issues from the Treasury, which temporarily drained cash from the economic system.
"Our opinion is that it surprised market participants a lot as well," Powell said. "People wrote about this and published stories several weeks ago. It was a stronger response than we expected."
But he said the New York Fed operations "were effective in relieving funding pressure."