Fed rushes to fill liquidity crunch in short-term loan market

  • The Federal Reserve had to pump some $200 billion into the US financial system this week as banks and other borrowers ran out of cash.
  • The capital injection marks the first time the central bank has taken action to support the so-called repo market since the 2008 financial crisis.
  • Still, economists say the liquidity crunch is due to technical factors and don’t see another crash on the horizon.

Washington — A strange thing is happening in financial markets this week: an often overlooked corner of Wall Street where banks and others go for billions of dollars in short-term loans suddenly needs cash.

To that end, the Federal Reserve has stepped in to inject about $200 billion over the past three days, with plans for another $75 billion on Friday.

The Fed took action after interest rates on such short-term loans soared, a sign that banks and other borrowers were running out of cash. Although there was similar turbulence in the so-called repo market in the run-up to the financial crisis, economists say there is no cause for concern this time around, the financial system is not about to crash as it did in 2008.

New trends

But it marks the Fed’s first major operation in the repo market since the crisis and it has sparked speculation about the underlying causes.

Among the possible causes suggested by analysts are the increased borrowing needs of the federal government and companies repaying their quarterly tax payments.

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Some economists have even suggested that the weekend attack on oil production facilities in Saudi Arabia may have played a role in increasing demand for cash from foreign banks with exposure to the Middle East.

“I think it was a shock coming from outside the US banking system,” said Brian Bethune, an economist at Tufts University in Boston.

The repo market describes billions of dollars of daily transactions in which one party lends money in exchange for a roughly equivalent value of securities, usually treasury bills. This market allows companies that own a lot of securities to earn money when they need it at cheap rates.

The cash borrower agrees to buy back the securities he has lent as collateral at a later date, often the next day.

Analysts say US banks are now much better capitalized and also have more liquidity, which should not make them vulnerable to the same shocks seen in 2008.

Deborah Cunningham, chief investment officer of global liquidity markets at Federated Investors, said this week’s tumult in the repo market was due to technical factors, not concerns about defaults or the strength of the economy. For this reason, she said it should have little impact on ordinary households.

“You wouldn’t notice it personally, even though it was in the headlines for a good part of the week,” she said. “You shouldn’t worry about loan rates going up.”

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The Federal Reserve announced on Wednesday that it was cutting its benchmark rate for the second time this year, lowering its target for the federal funds rate by another quarter point to a new range of 1.75% to 2%.

The funds rate, which is the amount banks charge each other for overnight lending, is the main way the central bank uses to manage short-term interest rates and it can be influenced by movements of the repo rate.

But Federal Reserve Chairman Jerome Powell said the Fed has the tools to smooth out any sudden moves in the repo market.

“We do not see this as having implications for the broader economy or the economic outlook, or for our ability to control rates,” Powell told reporters at a news conference on Wednesday after the announcement of the Fed rate.

“If we come under another bout of pressure in the currency markets, we have the tools to deal with those pressures,” Powell said. “We won’t hesitate to use them.”

Priscilla C. Carnegie