Unhinged Money Markets Trigger Fed Action to Alleviate Stress

The Federal Reserve Bank of New York injected funds into the banking system via an overnight repurchase-agreement operation for the first time in a decade, amid a rare mid-month surge in U.S. money-market rates.

The operation to keep the fed funds rate within its target range closed at 10:10 a.m. New York time, for $53.2 billion, the New York Fed said in a statement. The operation was initially canceled because of technical difficulties. Securities eligible for collateral included Treasury, agency debt and mortgage-backed securities.

In an overnight system repo, the Fed lends cash to primary dealers against Treasury securities or other collateral. The operation was “commonplace before the expansion of the Fed’s balance sheet in 2009,” according to a research note by Wrightson ICAP, which became its primary tool for implementing monetary policy.

The New York Fed declined to comment.

The interest rate for overnight loans collateralized by Treasury securities, which normally stays in the vicinity of the Federal Reserve’s target for the federal funds rate, spiked on Tuesday to a record level above 8%. It then settled back down around 2.5%, according to BMO. The squeeze pushed the effective fed funds rate up to 2.25%, in line with the top of the Fed’s target range of 2% to 2.25%.

Surges in the repo rate normally occur only at quarter-end, sometimes month-end. The mid-month surge was attributed to a confluence of events that knocked cash reserves in the banking system out of balance with the volume of securities on dealer balance sheets: a corporate tax payment date, settlement of last week’s Treasury auctions, and last week’s bond-market selloff, in which investors sold securities back to dealers.

“This is certainly painful for firms that have to fund positions,” said Thomas Simons, an economist at Jefferies LLC. “So it’s difficult for the dealer community. But it’s not systemically threatening.”