For the most part, we don’t pay much heed to the Fed’s daily market operations since the vast majority of it relates to maturing repurchase agreements, and too many commentators focus on gross rather than net injections, which gives an illusory view of the Fed’s actions (yes, we could get to the bottom of this, but it falls in the category of “too many topics, too little time”).
However, today the Fed announced an additional measure to increase liquidity: the use of longer-term agreements to inject funds. This move results from the fact that overnight lending rates were higher than the Fed’s target for seven out of the past eight days, plus increasing signs from the US and Europe of contracting liquidity, particularly bank reluctance to lend.
How significant a move this is remains to be seen. This isn’t a new practice; the Fed used longer-term injections a mere two years ago. It isn’t uncommon for there to be lower liquidity at year end, since many institutional investors curtail their operations considerably, typically around December 15, which is why the Fed’s latest action is far from unusual.
The proof of the pudding is how large an operation this turns out to be. The Fed announced other changes, which while more technical in nature, signal an intention to be accommodating. These measures have as much to do with shoring up confidence as supplying cash.
The Federal Reserve sought to ease concern that banks will be short of cash next month by planning its first long-term injection of year-end funds in two years.
The Fed’s New York branch said in a statement that it plans a series of repurchase agreements, starting with an $8 billion injection on Nov. 28, extending into next year. The move follows the European Central Bank’s commitment last week to make extra cash available to “counter the re-emerging risk of volatility” in money markets.
“The Fed is pulling out all stops to try to alleviate funding pressures in the money and financing markets as the markets lurch into year-end,” said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York.
Fed officials acted after the average U.S. overnight lending rate between banks exceeded their target seven of the past eight days, suggesting a reluctance to lend amid mounting subprime mortgage losses. In most years, banks face year-end pressures as they adjust their books to show ample liquidity and at the same time meet a jump in demand for cash from consumers.
The New York Fed said it planned the steps “in response to heightened pressures in money markets for funding through the year-end.” Officials will “provide sufficient reserves to resist upward pressures” on the benchmark federal funds rate around year-end. The Nov. 28 repo will mature on Jan. 10….
“What the Fed’s trying to do here is let the market know that they will provide liquidity around year-end, which is of particular concern in financial markets right now,” said Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc. “So anything they can do around that should help alleviate concerns.”
In repos, the Fed buys U.S. Treasury, mortgage-backed and so-called agency debt from its 21 primary dealers for a set period, temporarily raising the amount of money available in the banking system. At maturity, the securities are returned to the dealers and the cash to the Fed.
In a separate statement, the New York Fed said it will raise the limits on the amount of Treasuries that dealers can borrow from its System Open Market Account. Through the account, dealers can borrow Treasury notes and bills that are scarce in the repo market.
Primary dealers will be able to borrow 25 percent of the amount available, with a maximum of $750 million per Treasury security, up from the previous limit of 20 percent with a maximum of $500 million per issue, according to the Fed’s statement.