Sep 26, 2019

Fed's repo market troubles suggest something "very wrong" with the financial system

Illustration: Rebecca Zisser/Axios

Despite tens of billions of dollars of cash infusions every day for more than a week, things are getting worse, not better, in the systemically important repo market that banks use to access cash.

Driving the news: It's prompted the New York Fed to again increase the size of overnight cash loans offered to $100 billion a day, and to double the size of a 2-week offering to $60 billion.

Why it matters: The dysfunctional market signals "that something’s very wrong with the financial system," former Minneapolis Fed president Narayana Kocherlakota wrote in an op-ed for Bloomberg.

What's happening: The market is designed to operate so that banks with collateral like U.S. Treasury bonds can quickly trade those for cash, but a decreasing level of liquidity has banks "scraping the bottom" and relying on the Fed's infusions to conduct everyday business, strategists tell Axios.

  • The clearest evidence of this market stress was Wednesday when the Fed supplied $75 billion of cash and got $92 billion of offers, showing an extreme lack of available dollars.

What we're hearing: "Nobody knows right now whether this will blow over or not," Danielle DiMartino Booth, CEO of Quill Intelligence and a former adviser to the Dallas Fed, tells Axios.

Threat level: The injections are prompting suspicion the Fed is instituting a clandestine new phase of quantitative easing to boost asset prices and help stimulate the economy, but that's not the case, according to market strategists.

The big picture: The unexpectedly large budget deficits of the Trump administration, combined with the Fed's attempt to unwind its previously $5 trillion balance sheet, have caused a backup in the market. The Fed is now having to supply cash to fix the plumbing in a process that looks eerily similar to QE.

  • Strategists who have spoken with Fed officials are expecting the central bank to unveil a $300 billion–$500 billion standing credit line to the market at its meeting next month, in order to provide consistent liquidity and keep the market functioning.

The bottom line: "What the Fed is trying to do is make sure we don’t have episodes like this in the future," said Ian Lyngen, the head U.S. rates strategist at BMO Capital Markets, a primary dealer that does business directly with the Fed.

  • If the market dysfunction continues, "that’s going to weigh on corporate profitability, the cost of money becomes more expensive, and then it has real economic consequences," Lyngen tells Axios.

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Minneapolis Fed President Neel Kashkari has had it with the "hubris and stupidity" of Wall Street bankers. "Honestly, my patience for these market opinions is basically gone," Kashkari told Axios in an exclusive interview.

Driving the news: His latest grievances are with investors who claim the Fed is being bullied by President Trump and traders pointing fingers at the central bank for the liquidity crunch in the repo market, which the Fed just announced a $60 billion a month standing facility to address.

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Warren says big banks are crying wolf

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The banking industry has argued in recent weeks that the problems in the systemically important repo market are the result of excessive regulations and could result in larger and more damaging liquidity events in the future.

Driving the news: Sen. Elizabeth Warren wrote to Treasury Secretary Steven Mnuchin on Tuesday to call foul and request an explanation of what's really going on in the market.

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The big picture: The Fed chairman laid out his rose-colored vision of the country on Tuesday at the National Association for Business Economics conference. The economy is neither too hot nor too cold, inflation is under control, productivity is increasing, the job market is booming and the Fed is not (repeat, not!) engaging in a new quantitative easing program.

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