The Fed will test Monday the end of the third quarter

The Federal Reserve has used open market operations to appease the short-term financing market. Now, his temporary solution is facing a test as the third quarter ends.

The Fed used one-day and 14-day market operations to stabilize the market for pensions that financial institutions use to finance themselves in the short term. The Fed was reacting to a soaring rate on 16 and 17 September and is trying to permanently solve the problem, which seems to stem from a lack of liquidity in the day-to-day borrowing market rather than a crisis credit.

During the temporary panic in the overnight fund market, rates climbed up to 10%, and the Fed's benchmark federal funds rate briefly traded at 2.30%, 5 base points above the Fed's goal on Sept. 17. Exchange rate in the Fed's operations was at a moderate 1.80% on Friday. In recent days, the Fed has expanded its facilities to meet the high demand, but its subscriptions with day-to-day subscriptions, worth $ 100 billion, and its $ 60 billion over 14 days, have been under -used Friday.

"Clearly, things are calmer than last week, but there are still definite questions and concerns, we still have relatively high rates, whether in cash or mortgages. [this week]Said Ralph Axel, US rate strategist at Bank of America Merrill Lynch, "It remains to be debated whether the addition of additional reserves at this stage will affect funding end of the year ".

The repo is a corner of the financial markets that is obscure for most people. This is where institutions go when they need short-term cash, trading collateral, such as treasury bills or mortgage-backed securities, against a short-term loan. It is considered the plumbing of Wall Street, and the concern is that if it does not work or is not stressful, it could then lead to real tensions in the financial system.

The third day ended on Monday and the day-to-day repo market could face strong demand as banks reduce their credit operations to improve their balance sheets and close the quarter. Market professionals will monitor the use of the Fed facility and will check whether interest rates are rising again. The settlement of $ 113 billion of treasury bills, auctioned on Tuesday, Wednesday and Thursday, is also expected to generate strong demand.

"If things go wrong, the Fed will strengthen them … If the Fed starts having labor problems towards the end of the third quarter, it seems that the Fed will take drastic measures to ensure that the end of Is going well, "said Michael Schumacher. director, rate strategy at Wells Fargo. High repo rates prevent borrowers from maintaining the types of margins they need for certain types of investments. Hedge funds are a unique client for the repo market. "They need a repo … if the repo gets hard to get more expensive, it makes it more difficult for a hedge fund to position itself."

The major banks that are the main traders are the only institutions that can use the Fed facilities. They would then be lenders of other institutions in need of capital. but they could also be a bottleneck, as they are not required to declare how short-term funds are used.

"Banks are working hard to make their balance sheets particularly safe when they are going to publish their quarterly statements.That means they do not want to post a considerable amount of short-term commitments." in their balance sheet is a normal end-of-quarter phenomenon, "said Richard Bove, a banking analyst at Odeon Capital Group.

Another important rate, the guaranteed overnight rate, has also been significantly improved. SOFR, as we know, was at 1.85% Thursday, against 5.25% on September 17 and 2.01% Wednesday. This means that on September 17, 5.25% was the median rate of $ 1.2 trillion in short-term financing. SOFR allocates variable rates to approximately $ 285 billion in business and other loans.

Bove said that it appeared that the problems in the market were perhaps seasonal, but for some reason, demand and supply were unbalanced and we still do not see why the demand for cash was so high. This led to calls for the Fed to remedy the situation, which unexpectedly appeared in mid-September, not at the end of the quarter or during a period of financial market volatility. There were other brief periods of stress, particularly last December, during a massive sell off in the stock market.

"There has always been this problem between the Fed's monetary policy and the Fed's supervisory policy on banks, and the banks' supervisory policy since 2012 has been quite clear in terms of rest," Bove said. "The Fed did not want the banks to be involved in this market, it has established rules (…) aimed at forcing banks to lengthen their debt maturities and reduce the amount of funds they put in. in the country, repo market. "This has resulted in less support from banks than in the past.

Strategists have said that regulatory changes are part of the problem. Bank repurchase transactions are now compared to their capital ratios and could affect the amount of capital relative to the leverage that regulators should derive from them. In the fourth quarter, this becomes particularly acute as banks seek to improve capital ratios at the end of the year.

The Fed changed the rules when Dodd Frank's banking reform legislation was passed after the financial crisis, the last time the Fed had to intervene in the pension market.

The Fed should address the problem of lack of liquidity at its meeting on 29 and 30 October. It should also look at some of the solutions it had considered in the past, such as a permanent pension scheme in which it would be willing to intervene every day. . Another solution would be to expand one's balance sheet. The idea is to consider quantitative easing in the short term to expand its Treasurys portfolio.

The New York Fed manages market operations for the Federal Open Market Committee and was able to stabilize the market after it took office on September 17th. Strategists say Monday's result will be important to monitor the scale of demand for capital, plus what rate it is accepted. A sharp rise in rates would be a warning that the Fed should remain in control of the market in the fourth quarter, in the perspective of a long-term solution.

"I think it will be fine, because the New York Fed is keeping an eye on the issue, I do not worry," said Joseph Gagnon, principal investigator at the Peterson Institute. ;international economy. "I would not exaggerate the problem, as long as they react, they can keep it under control … Our goal is that they should have a more automatic system, so these problems are not resolved. " They do not return and are not obliged to continue to react, the main one being a permanent pension service, where people who wish to borrow can borrow at a rate set by the Fed … They should also increase their reserves and their balance sheet . "

The strategists, who are trying to shed light on this period of stress, attribute to the outbreak of last week soaring events. There was an increase in demand from companies that were making tax payments as well as investors who had to settle a lot of treasuries. But an unexpected event was the attack on Saudi Aramco, which knocked out half of its energy production. This would have prompted some investors to seek liquidity security, as well as speculation that Saudi Arabia itself was seeking cash as a temporary precaution.