While all eyes have been on the Federal Reserve today, the focus has unexpectedly shifted away from its decision on rates and toward what it might say about the $2.2 trillion repurchase agreement (repo) market. But experts are saying that worrisome headlines about this esoteric market may be overblown.
The repo market hinges much of the U.S. financial system, where banks and Wall Street dealers lend to one another to meet day-to-day financing needs. But this week, the repo market has been under pressure, forcing the Fed to intervene by injecting tens of billions of dollars of liquidity.
“What’s happened is that in the new world of very heavy regulation of banks, banks have very strong liquidity requirements and capital requirements,” Ethan Harris, Head of Global Economics at Bank of America Merrill Lynch, told Yahoo Finance’s YFi AM. “Banks want to hold very large amounts of reserves. And so the Fed has been kind of experimenting a bit with just how much do they need in order to keep funding the markets.“
This week, cash available to banks for their short-term funding needs all but dried up, forcing the Fed to inject $53 billion into the financial system on Tuesday and $75 billion on Wednesday to prevent borrowing costs from spiraling even higher. It was the first such intervention since the financial crisis more than a decade ago.
“What they (the Fed) discovered this week was they found the pain point, where reserves shrink because the Federal government was taking money out of its deposits in the banking system,” Harris said. “That created a stress in the funding market and big spikes in interest rates.”
“It’s a very temporary problem”
Harris added that while the Fed had troubles offsetting the situation, it’s a problem that’s easily fixed.
“The Fed’s already put a big bandaid on it by injecting more liquidity in the banks,” Harris said. “Eventually they’re probably going to have to do a more permanent addition of reserves to banks. But I don’t think it’s a sign investors should be worried about.”
“It’s a very temporary problem,” Harris assured. “It doesn’t tell us about any risks to the economy. It was just kind of a rough day for people that are in that narrow funding market that the Fed heavily influences.”
Fed Chair Jerome Powell suggested as much on Wednesday, saying: “While these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy.”
Ameya Pendse is a producer for Yahoo Finance’s live show YFi AM.