The Federal Reserve Bank of New York said Tuesday morning that it would pump as much as $75 billion of funds into short-term financial markets in an effort to relieve pressures that had sent overnight borrowing rates soaring.
The fund will be injected into the market through transactions known as repurchase agreements, in which the Fed temporarily swaps Treasuries and mortgage-backed securities from market participants in exchange for dollars. The agreements are expected to be unwound the following day, although they can be rolled over into new repurchases, or repos, if the market remains stressed.
After a brief hiccup that caused the Fed’s operation to be delayed by about 15 minutes, the Fed purchased about $40.8 billion of Treasurys, $11.7 billion in mortgage-backed securities and $600 million in debt of government-sponsored entities.
The massive repo transaction comes after a surge in the price of short-term funding that banks, hedge funds, and other financial institutions rely on to finance their securities portfolios. Repo rates, which typically stay close to the Fed’s target rate, spiked to more than 4 percent. The Fed’s target is currently a range of between two percent and two-and-a-half percent. In recent weeks, the repo rate had been around 2 percent.
Before the Fed’s announcement, rates had reached above 5 percent–with some traders saying they saw rates as high as 10 percent.
The reasons for the spike in overnight rates are still unclear. Some analysts have said that the sudden shift in the price of oil after the attack in Saudi Arabia could have created a scramble for dollars by large oil-importing countries. As well, Monday was the deadline for quarterly corporate tax payments in the U.S., which may have sent banks scrambling for funding. But that deadline was well-known in advance and should not have created such a big disruption.
A national holiday in Japan might also have created a shortage of repo buyers who supply dollar liquidity to the market. But that also would have been widely anticipated by financial markets.
The market was sent into even murkier territory when the Fed said that its first attempt at buying bonds in the open market on Tuesday morning had to be withdrawn because of technical difficulties. It returned to the market only a short while later, however, and rates promptly fell.
Big spikes in the overnight funding market carry with it memories of the financial crisis, when some of the nations largest financial institutions found themselves shut-out entirely and repo funding became very expensive, requiring massive central bank intervention around the globe. There was nothing this week, however, that indicated the repo market was responding to anything similar to those incidents.
The Fed uses short-term bond purchases to guide the market back to its target rate. But typically these are quite small and often just the knowledge that the Fed stands ready to provide liquidity is enough to keep rates close to the target. Tuesday was the first big test of the Fed’s readiness to supply large amounts of liquidity in several years.