Money Markets Brace to See If Fed Will Play Repo Whack-a-Mole

(Bloomberg) -- The Federal Reserve could be preparing to explain within days how -- or even if -- it will add a new mechanism to help keep a closer rein on how the central bank actually implements monetary policy.

Rates for repurchase agreements -- a central component of short-term funding markets -- have recently shown a tendency to spike, especially at month-end. The move was especially eye-catching at the end of 2018, but it’s also happened in subsequent months as financial institutions scrambled to secure enough financing to meet their needs, prompting those with capacity to lend to jack up rates.

While repo is not the market that the Fed targets directly -- its official target range is related to the fed funds rate, which has also been under upward pressure -- these disturbances have prompted concern. Some experts fret that if this keeps happening, it might undermine the central bank’s ability to control short-term interest rates more broadly. And the Fed has been dropping hints that it might do something to cap rates, even if the specifics are vague.

Minutes from the Federal Open Market Committee’s December and January gatherings offered clues. Also, the New York Fed asked primary dealers, the institutions who deal directly with the central bank, whether it should consider a new tool to keep money-market rates more under control, according to people familiar with the matter. A month ago, the St. Louis Fed published a blog post saying it’s “never too late” for the central bank to introduce a standing repo facility -- jargon for one kind of instrument that’s being considered.

Market watchers may learn more soon. On Wednesday, minutes from the FOMC’s March meeting come out. Observers will also hear on April 17 from Lorie Logan, a key New York Fed official who tends to be responsible for executing monetary policy at the direction of the FOMC.

“The Fed has dropped a lot of breadcrumbs pointing in this direction,” said Mark Cabana, head of U.S. interest rate strategy at Bank of America Corp. “If the Fed doesn’t talk now, it won’t seriously consider a facility going forward.”

There’s evidence the Fed is genuinely considering doing something, even if what that looks like isn’t clear. A standing repo facility is one of the tools that many think the Fed should look at. Such a mechanism would allow banks to convert Treasuries into reserves on demand, making it easier for them to get cash at crucial moments and potentially relieving upward pressure across money markets.

The minutes from December’s Fed policy meeting indicated some officials expressed an interest in learning about options for getting firmer control of short-end rates, while the account of January’s meeting mentioned the year-end repo spike.

That said, any appearance of a discussion within the minutes of the March FOMC meeting doesn’t mean a new tool is a foregone conclusion. There are myriad issues policy makers will have to sort out, from counterparties to how the rate used in the program will be set, as well as existential questions like what the Fed’s role in the larger repo market should be, or whether it should even be there at all.

“I don’t know if the Fed should be the source of repo liquidity on stress days,” said Blake Gwinn, a strategist at NatWest Markets in Stamford, Connecticut. “To say, ‘We’re going to be in the market in good times and bad times and regular times.’ I don’t think they want to become the repo market.”

Regardless of what the Fed ends up doing, there may be a short-term solution to address funding stress. Credit Suisse Group AG analyst Zoltan Pozsar has proposed that the central bank limit usage of its foreign reverse repo facility -- currently about $250 billion -- where central banks invest cash at the New York Fed at a rate that is comparable to market-based rates. A cap, Pozsar wrote last month, would ease quarter-end pressures and let the Fed get a new facility right.

“It’s a solution that buys time,” Pozsar said in a phone interview.

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Nick Baker

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