Fed well prepared to corral repo at year-end Fed well prepared to corral repo at year-end http://www.federatedinvestors.com/static/images/fii/fed-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\fed-puzzle-dollar-small.jpg January 21 2020 December 18 2019

Fed well prepared to corral repo at year-end

The central bank's full attention is on mitigating potential dislocations, and we think it will be successful.
Published December 18 2019
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The end of a year is a time to reflect on events that have transpired and to anticipate things to come. As we move to 2020, this will be particularly true of the repo market, which has dominated our conversations with clients in the fourth quarter. In light of this focus, we wanted to touch on the Federal Reserve’s plans for the end of the year and our expectations for the repo market as a result.

It didn’t take long after the mid-September spike in repo rates for the market to fixate on the potential for similar volatility on Dec. 31. These concerns persisted in spite of Fed operations that have added liquidity to the market on both a temporary and permanent basis since then—actions that have eliminated much of the day-to-day variability in repo rates. The worries may have begun to abate, however, with the Fed recently announcing plans for year-end operations to address any remaining liquidity needs. And they are substantial.

All told, through overnight and term operations, the Fed will make approximately $500 billion available to the market. This number gets even bigger when the permanent operations—its ongoing purchases of Treasury bills—are added in. With this enormous potential liquidity provision, the Fed cannot be faulted for failing to use its current tools to their full extent, although it deferred the decision to add new tools or address regulations that might be impacting the transmission of liquidity.

In fact, some of the onus must go on market participants to prepare, and indications are that they have. We are confident the combination should prevent a repeat of September’s volatility. Repo rates could still be higher than normal, as is typically the case on the last day of the year, but we are comfortable that any pressure will subside quickly and would reflect the plumbing of the repo market rather than credit stress. Finally, it is worth noting that the repo rates cited in the media most often reference borrowing costs for counterparties who do not meet our rigorous credit standards.

Many have speculated that the Fed’s actions are another wave of quantitative easing in disguise, a characterization that the Fed has vehemently denied. It cannot be denied, however, that the Fed’s presence in the repo market at the end of this year will be profound.

We expect the Fed to gradually reduce its footprint in early 2020, as permanent bill purchases boost reserves to a level that lessens the need for liquidity injections, at least on a regular basis. In the meantime, however, policymakers’ full attention is on mitigating potential dislocations on Dec. 31, and we think they will be successful.

Tags Liquidity . Markets/Economy . Monetary Policy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

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