Chaos in short-term funding markets this week led the Federal Reserve to step in with a series of overnight rescue operations to help keep credit flowing through the financial system.
Here are five things to know about gyrations in overnight lending rates, which several times in the past week spiked to almost 10%. The strain forced the Fed to open three daily borrowing facilities, so far, to add juice to funding markets.
Thursday morning’s $75 billion operation was the latest effort, bringing short-term borrowing rates on less risky collateral to about 1.8% to 1.95% in afternoon trade, according to Russ Certo, Brean Capital’s head of rates products.
That put borrowing levels within the desired range set forth by the Fed’s rate-setting committee, which voted Wednesday to cut the federal-funds rate to a 1.75% to 2% range and trim 5 basis points off the rate it pays banks to excess reserves at the central bank, or IOER, to 1.80%.
Who is bearing the brunt of higher repo rates?
Broker-dealers, hedge funds and other institutional investors who rely on leverage to run their operations are seeing the biggest impact of higher overnight repo rates, said Stephen Stanley, chief economist at Amherst Pierpont, which in May became one of 24 primary dealers in the U.S. Treasury debt market.
“The repo market is the market where people running leveraged positions borrow,” Stanley told MarketWatch in an interview. “Obviously, that doesn’t apply to 401(k) funds or mutual funds, where you are investing real money without leverage.”
Most of the pain was felt Monday and Tuesday when overnight rates spiked above 6%.
“If you were a securities dealer or bank financing a $20 billion balance sheet and you had to deliver on rates at the 6%, 7% or 8% level, you got crushed,” said Tom di Galoma, a managing director at Seaport Global Holdings, in an interview.
But di Galoma also stressed that the recent Fed operations have been a success in terms of bringing rates down and liquidity back into the financial system. He expects additional overnight interventions over the next couple of days of up to $75 billion.
“I think the Fed will keep a tight grip on it,” he said.
Should more stress be expected?
Pacific Investment Management Company said that soaring repo rates earlier this week can be tied to a culmination of events, including $35 billion of corporate tax payments and dealers needing an extra $20 billion in funding to settle recent U.S. Treasury issuance, which helped sap market liquidity.
However, portfolio managers at the bond colossus also see cause for future funding squeezes.