They executed approximately $140 billion of term repo and approximately $63 billion of overnight repo over the September quarter end. This seems to have done the trick as the secured overnight financing rate traded in a tighter range.
Not to be forgotten, the Fed’s ease in their policy rate also came with additional stimulus for the market. In an effort to pull the Fed Funds Effective Rate further back into the Fed’s target rate channel the Fed lowered two key policy rates by more than 25 basis points (bps). The Fed’s Interest On Reserves (IOR) and the Fed’s Reverse Repo Program (RRP) rate were both lowered by 30bps on September 18. This was the fourth time the Fed lowered IOR more than how much the target rates range was lowered. IOR now sits 20bps below (1.80%) the top of the range (2.00%), whereas it once defined the top of the range. It was the first time the Fed moved their RRP rate lower (1.70%) (RRP is the Fed borrowing cash and pledging collateral). As some might remember when the Fed’s RRP was first announced on September 23, 2013, the rate was 1bps and the target rate range was between zero and 25bps. With very little activity at 1bps, they moved it to 5bps where it stayed until the first rate hike, at which point it was only raised by only 20bps to 25bps. Subsequently, it was raised by 25bps at each meeting there was an adjustment up in policy rate and it defined the bottom of the Fed’s target rate range. Now it is 5bps below the bottom of the range. This illustrates the Fed is always tinkering with policy rate to effect shortterm rates so rates stay within their policy range. It’s clear this is more art than science.
There is an expectation that the Fed will put in place a standing repo facility at some point during the fourth quarter of 2019. The facility will be similar to the RRP but opposite in liquidity movement, injecting liquidity rather than removing. It will also be similar to the TOMO but permanent. Some experts think the Fed will need to inject as much as $400 billion of liquidity into the market. This will involve putting in place a program that will buy or repo US Treasury securities. The Fed buying US Treasuries to control overnight rates should not be confused with quantitative easing. Prior to the global financial crisis the Fed would engage in open market operations to inject or remove liquidity from the market. This was part of the process to control the Fed funds trading range and maintain control over short-term rates. Post-crisis the Fed implemented quantitative easing to attempt to anchor or lower US Treasury rates. They wanted to influence rates lower to ease monetary conditions and promote growth. A by-product of allowing their quantitative easing program to unwind, or what was referred to as quantitative tightening, is the draining of reserves as banks needed the reserves to pay for the US Treasuries that were being issued into the market. Thus creating a different problem for the Fed and one that will require further action as described above.
So what does all this mean for the US money market and cash investors? Fortunately, not much. The drama we saw the week of September 16 confirmed the need for a standing repo facility or at the very least the need for open market operations, just as the Fed put in place. After the Fed’s action on Tuesday, September 17, the markets started to calm. Their announcement Tuesday afternoon that more liquidity would be in market by the next day at 8:15am and in the following days further calmed the market. Finally the announcement they would do term repos by quarterend all caused the repo market to calm down and pull itself back together. Crisis averted.
So how should we plan for the final quarter of 2019 and further plan into next year? The market tells us that money market rates will be lower by the end of the year. Most agree with Fed fund futures pricing at 70% to 80% probability of at least one more 25bps cut in rates this year. The futures market also tells us there is a high likelihood of another 25bps rate cut in the first quarter of 2020. But we are keenly aware that the Fed will watch the data and the markets to determine the appropriate course of action.
Right now credit spreads in the money markets are behaving similarly to what they did last year during the fourth quarter. We have seen a gradual widening in anticipation of funding pressure going into the end of the year. This has been very well known. The yield differential between Libor and Overnight Index Swaps (LOIS) is a proxy for money market credit spreads and the spread has been gradually creeping wider over the past three months and is expected to reach its apex in December. The LIOS forward market confirms this.