Rate woes: Logan speaks at a research conference in Dallas, Texas. The president and chief executive officer of the Dallas Fed says she is disappointed to see tri-party repo rates exceed the monetary authority’s rate on the Standing Repo Facility. — Bloomberg
NEW YORK: Strains in money markets could persist into November as funding costs remain stubbornly high, building pressure for the Federal Reserve (Fed) to bolster liquidity even before it stops shrinking its portfolio next month, according to Wall Street analysts.
The markets ended a volatile month with the Secured Overnight Financing Rate (SOFR), a benchmark based on the cost of borrowing against Treasury securities, surging by 18 basis points last Friday.
That was the biggest one-day move outside of a Fed interest rate hiking cycle since March 2020.
While SOFR dropped on Monday after month-end related pressures eased, it remains above key policy benchmarks targeted by the Fed.
Other short-term rates in overnight repo markets, where banks borrow and lend to each other, continued to trade above the Fed’s administered rates as well.
“The Fed is out of time and it seems like they’re scrambling,” said Mark Cabana, head of US interest rate strategy at Bank of America Corp.
The central bank last week said it would stop shrinking its treasury holdings beginning in December, ending a three-year long effort, known as quantitative tightening (QT), as funding strains intensified in recent weeks.
Money market liquidity has been drying up as a flurry of government issuance since the summer has lured more cash away from the market just as the Fed kept on tightening its portfolio.
Bank of America had expected the Fed to conclude QT at the end of October and immediately start asset purchases to grow the balance sheet.
The lack of such measures indicates there are “diverse views” within the Fed, Cabana said.
Fed chair Jerome Powell said last week that “at a certain point” the Fed would start gradually adding reserves to keep up with the size of the banking system and the economy, though he didn’t indicate when.
Other Fed officials, including Fed vice-chair for Supervision Michelle Bowman, have argued that the central bank should have the smallest balance sheet possible. A spokesperson for the Fed declined to comment.
Bank of America strategists believe the Fed has overdrained reserves, allowing them to fall to levels that would be considered “ample”, the minimum needed to cushion against market distortions.
Bank reserves fell to US$2.8 trillion, the lowest level since September 2020, according to the latest data.
Dallas Fed president Lorie Logan said last Friday that the Fed would need to buy assets if repo rates stayed elevated, adding that she was disappointed to see tri-party repo rates exceed the monetary authority’s rate on the Standing Repo Facility, the Fed’s liquidity backstop.
Logan, who spent more than two decades at the New York Fed’s markets desk, has also argued that the central bank should operate with money market rates on average close to or slightly below the interest on reserve balances (IORB).
Last Friday, SOFR rose 32 basis points above IORB, the widest since 2020, before easing to 4.13% on Monday.
It remains above IORB, currently at 3.9% and the effective Fed funds rate, which policymakers last week cut by a quarter-point to a range of 3.75% to 4% on Oct 29. — Bloomberg
