For the second time in two days, the US Federal Reserve has been forced to inject another $US75 billion in emergency funding into the US money markets to ease a liquidity squeeze.
The first time happened out of the blue on Tuesday when a sudden shortage of cash saw short term interest rates soar to 10% as a key market dried up.
The Fed used $US53 billion of a $US75 billion funding pot to provide liquidity to the repo market on Tuesday but Wednesday saw that demand soar to $US80 billion.
In a sign of the intensity of the cash crunch the Fed’s main policy rate, the federal funds rate, jumped above the central bank’s 2% to 2.25 %.
Data released on Wednesday morning showed the rate rose to 2.3% on Tuesday, from 2.25% on Monday and 2.14% at the end of last week.
The market handles repos where banks and money market and other investors provide billions of dollars a day in cash in exchange for Treasury bonds and other high rated securities via repurchase agreements or repos that reverse overnight. In other words the money is borrowed during the day and repaid the following day.
The Fed’s New York branch told markets before they opened on Wednesday that it had another $US75 billion ready to inject into the system around 10am New York Times (midnight Sydney time).
The US central bank was forced to inject the cash after a severe imbalance in the repo market sent the cost of borrowing cash overnight, known as the repo rate, surging to a historic peak of 10% (it should be around the level of the Federal Funds rate, now 1,75% to 2% after the latest cut on Wednesday).
The Financial Times reported “The Fed had not previously used its repurchase agreement auction mechanism outside of small tests since the financial crisis in 2008 and encountered a hiccup on Tuesday as it attempted to open the facility for a large-scale operation.”
further reported “US funding markets were shocked this week as a combination of factors reduced the amount of cash available to fund securities positions,” said Alex Roever, head of US rates strategy at JPMorgan Securities, one of the two dozen primary dealers that act as trading counterparties for the Fed.
Analysts said the Fed’s dramatic intervention should be seen as a valve meant to release pressure on the repo market, in which banks and funds provide cash in exchange for Treasuries and other securities in transactions that reverse overnight.
Joseph Abate, a managing director focusing on money markets at Barclays Capital, another primary dealer, told the FT that a combination of “temporary pressures” had struck the crucial portion of the financial system in recent days.
Analysts specifically pointed to companies withdrawing billions of dollars out of money market funds, which are typically major providers of cash in repo transactions, ahead of tax deadlines as well as a flood of Treasuries bond raisings hitting the market, something that increased dealer demand for overnight cash via repo transactions.
As well big US Banks, which typically step into the repo market, also had less cash available because of a decline over the past several years in their excess reserves held at the Fed, said Mr Roever in an interview with the FT.
The surge in rates in the repo market triggered a rise in short term rates for business in the US commercial paper market which is used by American corporates daily to fund short term cash flow needs or earn a return on funds invested.
What made the liquidity squeeze notable is that it came ahead of the two day meeting of the Fed that ended early Thursday morning, Sydney time.
The funding is not an easing of monetary policy and all being well the $US150 billion or so involved will be returned to the fed by Friday.
Analysts at the moment say it is not a repeat of the liquidity crisis that emerged in early August 2007 after Bear Stearns was taken over to stop it collapsing. That started the GFC and the collapse of Lehman Brothers in September 2008.
