Fed continues to intervene in repo market

The Federal Reserve announced new long-term repo operations to avoid liquidity problems in the money market by the end of the year. In addition to daily and 14-day repo operations, new liquidity injections of 28 and 42 days will be made. This will enable banks to strengthen their liquidity position towards the end of the year.

The two 42-day support operations amount to $25 and $15 billion and will take place on 25 November and 2 December. On 9 December, the Fed will also make available $15 billion for a single 28 day repo operation. It complements the existing 14-day repo operations. These adjustments should ensure that banks have sufficient reserves at least until the end of this year, according to an explanatory memorandum issued by the central bank.

Fed continues to intervene

The Fed has been intervening in the repo market for two months now, increasing the amount of liquidity available in exchange for high-quality collateral. Banks that need liquidity can call on the central bank for up to $120 billion a day. They can also subscribe to the long-term repo operations.

In turn, banks offer government bonds and mortgage loans in exchange for liquidity. It concerns short-term liquidity support, because banks have to reverse this exchange at the end of the set period. However, this facility is becoming permanent, as available liquidity increases and maturities are extended.

Fed adds new long-term support operations (Source: New York Fed)

Billions in liquidity support

The chart below shows how much liquidity US banks have requested from the Fed since 17 September. The largest part consists of so-called overnight repo operations, which banks settle within one day and are therefore rolled over. So we cannot simply add up the amounts from the chart below.

The Federal Reserve continues to provide the market with liquidity (Source: New York Fed)

Balance sheet total growth

With these support operations, the US central bank reversed eight months of tapering in just two months, as shown in the chart below. Since the first intervention on 17 September, the Fed has already added more than $200 billion to its balance sheet. These are government bonds and mortgage loans, which were on the bank’s balance sheets as excess reserves.

The chart below shows that there is a strong correlation between the central bank’s buy-back schemes and the excess reserves in the banking system. The Fed withdrew bonds from the market and in return, banks receive a credit from the central bank. In the last two months, the Fed’s balance sheet total has increased by more than $200 billion, while banks’ excess reserves have not increased accordingly. This is because these new support operations by the Fed are meant to be temporary.

Balance sheet total Federal Reserve growing, excess reserves not (Source: St. Louis Fed)

Temporary or permanent support?

The intention is that the central bank will eventually remove this extra liquidity from the market, but more and more market participants are beginning to doubt it. After all, the Fed has continued to extend the duration and scope of its repo operations. In October, the central bank also started a $60 billion per month buy-back scheme.

We can therefore conclude that the US banking system is still not functioning properly. The Federal Reserve is playing an increasingly important role in the money market, while these activities should normally take place within the banking system.

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