Today, Friday, September 20, the Federal Reserve will buy another $75 billion in the overnight repo market. That brings the total this week to $203 billion in the Fed’s effort to stabilize the short-term markets that Wall Street uses to finance its purchases of Treasury debt.
The moves have worked to calm one part of the funding market where the overnight repo rate has dropped to more normal levels near 1.75% after spiking to 10% on Tuesday. The underlying cause is that huge auctions of Treasury debt are leaving Wall Street purchasers with a need for very short-term money at a time when liquidity in the short-term money markets has been very tight. That has left big Treasury purchasers chasing available short-term funds, sending the rate on this money soaring.
The Fed’s purchase of more than $200 billion of assets in the repo market has provided the needed liquidity–for the moment.
But not all signs of stress have disappeared. Spread in the swaps market fell to record lows on Thursday signalling potential trouble in future Treasury sales because traders are worried that they won’t be able to fund their purchases. (Big buyers of Treasuries at auction don’t hold onto their purchases for very long. The primary dealers resell them to other big buyers who then, in turn resell them. Most of those purchases, though, need to be funded in the short-term with borrowed money. One source is the repo market, which lets buyers of Treasuries use them as collateral for loans from the Fed to fund those purchases. If there isn’t enough money available in the repo and other short-term funding markets, buyers may have to pay so much to borrow that they will curtail their purchases of Treasuries out of a fear of losing money on the transaction or being unable to fund their purchase at all. The last thing the Fed wants is for Treasury auctions to run into problems. That would create enough worry at the short-end of the market to put the Fed Funds rate higher just as the Fed is trying to cut that interest rate to backstop a slowing economy. That’s what happened just before the Fed cut interest rates on Wednesday. On Tuesday the rate in the Fed Funds market climbed to 2.3% even though the Fed had declared a Fed Funds range of 2% to 2.25%.
The worry about funding for Treasury sales is growing because the U.S. Treasury has announced an aggressive schedule of sales as it looks to fund the government into the end of the year.