The Federal Reserve surprised some traders on Wednesday by saying it would increase the amount of money it is injecting into overnight lending markets, seeking to avoid a repeat of the cash crunch that sent short-term borrowing rates soaring in September.
Beginning on Thursday, the Fed will increase the size of its overnight operations for the repurchase or “repo” market, where banks and investors borrow cash in exchange for Treasuries and other high quality collateral.
The markets arm of the US central bank said it would raise the limit on the amount of cash it will lend into the market to at least $120bn, up from the $75bn it had previously agreed to supply on a daily basis.
It also said it would boost the amount it lends in the slightly longer-term, two-week repo market to at least $45bn, to cover any cash needs over the end of the month. Previously, the Fed was offering $35bn.
The dramatic increase in the size of the operations caught some market participants off guard, because the Fed has largely been able to accommodate banks’ demands for its loans on offer recently. Bids have only outpaced what the Fed is willing to supply on two occasions since the beginning of October.
“This is the first time it feels like they are not responding to the market,” said one repo trader. “I don’t see a reason to upsize the overnight operation so substantially.”
The move comes two weeks after the central bank announced it would buy $60bn of short-term Treasury bills each month between now and the second quarter of next year, in order to restore the amount of reserves banks hold at the Fed to a level high enough to keep borrowing costs within its target range. To date the Fed has purchased roughly $30bn.
In September the cost of borrowing cash overnight in the repo market jumped as high as 10 per cent, a roughly fourfold increase from its level the week before.
The flood of cash entering the repo market from the Federal Reserve has served to dampen concerns that a repeat of the bout of volatility could occur at the end of the year, when banks typically retreat from the market and shrink their balance sheets for December 31 regulatory calculations.
“The safety net is pretty big at this point,” said Guy LeBas, chief fixed-income strategist at Janney Capital Management. “I think the Fed is going to put an ocean of funding into the market until there is no way for repo rates to rise.”
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