(Adds more analysis and context)
By Jonnelle Marte and Karen Brettell
March 3 (Reuters) - Heightened concerns about the spread of the coronavirus and its impact on the U.S. economy could boost the need for liquidity and force the Federal Reserve to rethink its plans to scale back the support it offers to money markets, analysts said Tuesday.
The Fed’s emergency interest rate cut, aimed at countering the negative effects of the virus, came on a morning when the central bank saw strong demand for the temporary injections it is making into the market for repurchase agreements, or repo. The cost of borrowing overnight in the repo market was also elevated for a second day.
“People are interested in securing funding as it appears things are going to get worse before they get better,” said Ian Lyngen, head of U.S. rates strategy for BMO Capital Markets in New York.
Investors requested nearly $71 billion in term repo funding from the Fed, or three and a half times the maximum offering of $20 billion. The rate on overnight repo also rose temporarily to 1.80% before coming down to 1.70% after the Fed announced the rate cut. Some analysts viewed the large demand as a sign that banks want to shore up their liquidity to prepare for any volatility caused by the virus.
“The market was clearly communicating via the oversubscription that the Fed was not offering enough,” said Danielle DiMartino Booth, founder of Quill Intelligence and a past adviser to former Dallas Fed President Richard Fisher.
The Federal Reserve has been pumping liquidity into the repo market since last September, when demand for the short-term loans overwhelmed supply and led to a spike in borrowing rates.
The central bank has also been increasing the size of its balance sheet since mid-October by purchasing $60 billion a month in short-term Treasury bills, an effort policymakers have characterized as a “technical” move meant to boost liquidity in money markets.
The Fed has been reducing the size of its offerings in the repo market this year and Fed Chair Jerome Powell has previously said the central bank could reduce its bill purchases in the second quarter. But uncertainty over the outbreak could require the Fed to prolong its balance sheet expansion and potentially boost the size of its repo offerings, some analysts said.
“I think they’ll err on the side of providing more accommodation to the repo market,” said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics.
Policymakers could also encourage banks to turn to the discount window, the Fed’s emergency lending facility, if they are short on reserves, Bostjancic said.
The next update on the schedule for bill purchases and repo operations should be issued on March 12, according to the New York Fed’s website. (Reporting By Karen Brettell)