The Federal Reserve’s ongoing efforts to shore up the short-term “repo” lending markets have begun to rattle some market experts.
The New York Federal Reserve has spent hundreds of billions of dollars to keep credit flowing through short term money markets since mid-September when a shortage of liquidity caused a spike in overnight borrowing rates.
But as the Fed’s interventions have entered a third month, concerns about the market’s dependence on its daily doses of liquidity have grown.
“The big picture answer is that the repo market is broken,” said James Bianco, founder of Bianco Research in Chicago, in an interview with MarketWatch. “They are essentially medicating the market into submission,” he said. “But this is not a long-term solution.”
This chart shows the more than $320 billion of total repo market support from the Fed since Sept. 17, when for the central bank began pumping in daily liquidity after overnight lending rates jumped to almost 10% from nearly 2%.
Initially, the central bank rolled out roughly $75 billion in daily lending facilities to arm Wall Street’s core set of primary dealers with low-cost overnight loans to keep the roughly $1 trillion daily U.S. Treasury repo market running.
The facilities allow banks to snap up loans by pledging safe-haven U.S. Treasurys or agency mortgage-backed securities with the New York Fed, but crucially without the typical risk-based pricing that lenders regularly charge when funding each other.
The goal was to keep banks flush as they deal with month-end funding issues, corporate tax payments, and the deluge of Treasury debt being sold by the federal government to fund its deficit.
Shortly thereafter, former New York Fed markets group head Brian Sack, now director of global economics at hedge fund D.E. Shaw Group, coauthored an article saying that the Fed could get a better control of overnight rates if it were to boost banking system reserves by purchasing $250 billion of Treasury debt.
But the Fed’s total support already has eclipsed that threshold with the expansion of daily operations, the introduction of longer-term loans, and its balance sheet expansion through monthly T-bill purchases.
“This is now far bigger than anyone thought this was going to be,” Bianco said. “I think they’re hoping the market will magically fix itself. I don’t see why it would.”
Amid sustained clamor for Fed funding, the central bank in the last two weeks said it would increase two longer-term facilities to help carry borrowers through any year-end turbulence.
The changes came as U.S. stocks fell from November’s all-time records with the Dow Jones Industrial Average ( /zigman2/quotes/210598065/realtime DJIA -0.44% , S&P 500 index /zigman2/quotes/210599714/realtime SPX -0.38% and Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP -0.67% retreating on fading hopes for a U.S. - China trade dea.