The United States Federal Reserve has added $90.8 billion to financial markets in order to allow institutions to continue lending to the repo market whilst maintaining their legally required reserves.
According to the Wall Street Journal, the Fed balance sheet is $380 billion greater now - $4.18 trillion – than the $3.8 trillion level in September when a lending shortage in the repo market first came to light.
The repo market refers to behind-the-scenes banking where hedge funds and private equity funds borrow from money market funds in 24 or 48-hour short-term loans. These usually come with a collateral guarantee in the event of failure to repay, making them popular quick-fix loans for balance sheets. Due to the nature of them, such dealings have come to be known as ‘shadow banking’, but the reality is that a lot of the information is well reported in the financial press.
The last time that the repo market hit the headlines was during the ‘Great Recession’ aka the 2008/09 financial crisis. Prior to the domino effect of the global recession, there was a collapse in the US repo market between 2007 and 2008. Funding became unavailable due to debt defaulting, which led to heavy intervention from the Fed.
There have been blips on the radar since then, but September 2019 was the first significant moment to worry the Federal Reserve. September saw a sharp rise in the repo lending interest rate, which hit nearly 10% and deterred a lot of borrowers. Bloomberg reported that lenders blamed the Federal Reserve rules about how much cash had to be held in reserve, while PricewaterhouseCoopers (PwC) went further, attributing it to “tightened level of reserves in combination with a spike in liquidity needs due to a confluence of quarter-end corporate tax payments, a large settlement of Treasury securities, and even Saudi Arabian spending on oil refinery repairs.”
The US Fed’s target interest rate is 2%, but with five times that on offer, banks and other funds weren’t willing to lend for less. The Fed stepped in directly and offered a much fairer 2% rate to borrowers, who gladly took them up on their offer. This dragged the repo rate back down, and pulled the hesitant lenders back into the market.
This was the first intervention for over a decade from the Federal Reserve, and there has been $380 billion injected by the Fed in the four months since the repo rate spike. In an article by MarketWatch early last December, experts aired their concerns that the repo market is now a) dependent on the Fed and not each other, and b) unwilling to divert from the 1.55% interest by keeping money with the Fed rather than in the repo market.
In the past week, CNBC reported that the repo market is in less dire straits than it was in September, but despite this the Wall Street Journal believes that the repo operations – due to end on January 31 – will actually continue until mid-February and probably beyond that date. This grants short-term stability, but could affect the repo market’s viability long-term.