Fed keeps cash spigot open as key rate punches above its target

Fed keeps cash spigot open as key rate punches above its target

NEW YORK (Reuters) – The Federal Reserve injected more cash into the U.S. banking system on Wednesday as the key interest rate pierced above the central bank’s targeted range for the first time since the height of the global financial crisis over a decade ago.

FILE PHOTO: The Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 27, 2019. REUTERS/Brendan McDermid

The ructions in the money market come as Fed policymakers are convening to decide whether to lower key lending rates to combat risks from U.S.-China trade tensions, a slowing global economy and sluggish domestic inflation.

This puts pressure on Fed officials to come up with long-term fixes – such as a standing repo facility and cutting interest on what they pay on excess reserves (IOER) and growing its balance sheet – to avert further volatility in funding markets and to add more permanent reserves into the banking system, analysts said.

The Fed is scheduled to issue a policy statement at 2 p.m. ET (1800 GMT), following by a press conference with Chair Jerome Powell at 2:30 p.m. (1830 GMT).

Concerns over problems in money markets spreading have been muted so far.

“I don’t believe it is a signal of concern, I think it is an aberration,” said Ken Polcari, managing principal at Butcher Joseph Asset Management.

Dollar money markets have wobbled this week as banks and Wall Street dealers scrambled to find daily funding for their trades and loans.

Analysts have blamed quarterly corporate tax payments and settlement on $78 billion in coupon-bearing Treasury securities on Monday for a severe drop in cash for wholesale lending.

These factors sent borrowing costs in the $2.2 trillion repurchase agreement (repo) market soaring to 10% at one point on Tuesday, nearly five times Fed’s policy rate.

“The question really becomes how is the Fed going to make sure we don’t have this volatility in the repo markets,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale in New York.

With evidence that market distress would push the federal funds rate above its target early Tuesday, the Fed deployed a maneuver it had not used since the credit crunch to add liquidity into the bank system.

“This is what caused them to jump into action,” said Lou Crandall, chief economist at Wrightson ICAP LLC.

In fact, the “effective” or average interest rate in the federal funds market, which the Fed aims to influence, hit 2.30% on Tuesday, above the top-end of the Fed’s current range of 2.25%. Such a move has not happened since 2008.

The New York Federal Reserve, which conducts open market operations for the Fed system, held an overnight repo operation on Tuesday, resulting in a $52.15 billion cash infusion into the banking system.

In an overnight repo operation, banks borrow cash from the Fed using Treasuries and other securities as collateral.

Another repo operation on Wednesday injected $75 billion.

These operations have reduced repo rates, which were last quoted at 2.10%-2.25% on Wednesday.

They also seemed to lower the rates in other money market instruments such as Treasury bills.

(GRAPHIC: U.S. repo rate, here)

Reporting by Richard Leong; Additional reporting by Chuck Milolajczak, Karen Brettell; Editing by Jon Boyle and Bernadette Baum

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