September 20, 2019 / 6:29 PM / 24 days ago

U.S. Fed primes cash pump as quarter-end approaches

NEW YORK (Reuters) - The Federal Reserve plans to keep pouring tens of billions of dollars a day into the U.S. banking system through early October in a bid to avert another market disruption as the end of the quarter approaches, a time when lending typically diminishes.

Earlier this week, interest rates in the repurchase agreement, or repo, market soared to levels not seen since the height of the global credit crisis in 2008.

Banks and Wall Street rely on this $2.2 trillion (£1.76 trillion) market for daily cash to fund their loans and trades in other markets, including stocks and bonds.

Since Tuesday, the Fed has held four rounds of repo operations, with banks and dealers borrowing from the central banks with their Treasuries and other bonds as collateral. This has added up to $75 billion each day in the banking system.

On Friday, the New York Fed, which implements the central bank’s market actions, said it will conduct more repo operations into October in overnight and longer-term loans.

“Quarter-end is the issue. There is too much collateral out there that needs funding,” said Steven Zeng, interest rates strategist at Deutsche Bank in New York. “The Fed is essentially helping to provide a funding backstop for those positions.”

Repo rates USONRP= hit 10% on Tuesday, propelling other short-term rates sharply higher. They were at 1.85%-1.95% early Friday afternoon.

For a graphic on U.S. repo rate:

here

Analysts blamed the repo swings on huge demand for cash to pay for quarterly corporate taxes and the prior week’s $78 billion worth of coupon-bearing Treasury supply for the market ruction earlier this week.

Treasury issuance will be a factor again as the quarter comes to a close: Monday, Sept. 30, will be the settlement date for $113 billion of Treasury notes that will be auctioned next week.

Analysts also said a decline of bank reserves contributed to the market’s choppy behavior. They are down to about $1.4 trillion from $2.3 trillion in 2017 as the Fed has reduced its bond holdings.

The Fed jumped into action early on Tuesday, adding temporary cash on a large scale for the first time in more than a decade to calm jittery markets.

This move was on top of the Fed cutting the interest it pays banks on reserves and reverse repos on Wednesday.

What alarmed the Fed on Tuesday, some analysts say, unlike recent episodes when repo rates spiked, was that there was a strong indication the borrowing cost in the federal funds market was rising above the top end of the central bank’s target range, which was 2.00%-2.25% at the time.

The Fed targets the federal funds rate USFOMC=ECI to conduct monetary policy.

If this condition were to persist, it could stoke fears in markets that policymakers are losing control of short-term interest rates, analysts said.

Dallas Fed President Robert Kaplan told reporters after an event in Corpus Christi, Texas that the central bank “should be seriously examining plans to let the balance sheet increase with growth in the demand for reserves.”

Until the Fed comes up with longer-term fixes such launching a standing repo facility and/or increasing purchases of Treasuries for its balance sheet growth, the central bank will likely keep up with these repo operations to fill gaps in daily funding, analysts said.

“Funding conditions are getting better,” Zeng said. “This is the Fed being cautious.”

For a graphic on U.S. primary dealers’ Treasury holdings:

here

Reporting by Richard Leong; Additional reporting by Ann Saphir; Editing by Chizu Nomiyama and Dan Grebler

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