The Federal Reserve recently took action that it has not taken for a decade since the Great Financial Crisis. In two separate instances, the New York Fed injected money into the banking system through an overnight repurchase agreement, or repo. The injection is designed to assist the Fed in keeping interest rates under control and the Fed Funds rate within the desired range.
According to businessinsider.com, short-term interest rates had spiked up to as high as 10 percent, threatening to put a major monkey wrench into the bond market and the lending system. An initial injection of $53 billion by the New York Fed did not do much to lower borrowing costs, so the central bank elected to inject another $75 billion the following day.
The reason behind the lack of cash on hand for short-term lending by banks is the subject of some debate. A liquidity squeeze is typically the result of investors’ unwillingness to lend money (as was seen during the financial crisis) or if there is not enough cash in bank reserves to be lent out. The latter was the cause for the recent spike in short-term lending rates, and the shortage did coincide with tax bill time and the issuance of billions in new bonds by the Treasury Department.
Higher volatility in the $2 trillion repo market may be due to the widening gap between Federal revenues and expenditures. The U.S. deficit is at the highest level in years, and a further increase in the deficit could fuel further volatility and the need for more intervention.
The Fed has not only injected money into the banking system, but it recently cut the Fed Funds rate by another 25-basis points. The central bank appears to be looking to stay ahead of the curve as the global downturn continues, and further rate cuts may prove necessary if the data suggests an acceleration of the slowdown.
There is growing debate, however, about the necessity of further rate cuts and the economic outlook. President Trump has been very vocal about his desire for lower rates, but the Fed has thus far been reluctant to take a more aggressive approach to easing. Despite some recent bumps and the ongoing trade war, the labor market and overall economy continues to be robust, and the need for further central bank measures may dissipate if an agreement on trade is reached.
Markets are pricing in another rate cut by the Fed this month, and from there the central bank will likely take a wait and see approach that is data dependent.
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