Quantitative Pleasing

Last Friday we published this note about the recent disruption in the repurchase agreement (repo) market.  This is a short-term lending resource for various financial institution (banks and non-banks alike) to borrow cash by temporarily selling high-quality assets and promising to buy them back at a higher price. 

While the cause is not fully understood, this market went through a major hiccup in September of this year which caused borrowers of cash to pay nearly 10 percent interest for loans maturing in a matter of days.  The Federal Reserve began pumping trillions of dollars directly into the market place, hoping to curb the surging interest rate.  And they are prepared to do even more.

After each Federal Open Market Committee (FOMC) meeting, our central bank hosts a press conference and Wednesday was their last one of the year.  During the Q&A FOMC Chair Jerome Powell expressed the Fed’s willingness to make changes to their monetary tactics if they are unable to maintain interest rate stability in the repo market. 

They have already been taking abnormal actions to sustain order.  Last week they announced they were increasing the amount available for both 28-day and 42-day loans to keep the peace through the end of the year.  Prior to September, they weren’t even intervening in this space and hadn’t in material ways since before the end of the Great Recession.  Now it appears the Central Bank may have brought this upon themselves, and this could make it tough for them to stop providing liquidity.

When the Fed expanded its balance sheet via Quantitative Easing (QE), they were buying lots of treasury debt from the large banks to suppress interest rates.  In turn, big banks had plenty of cash on hand and were willing to lend in the repo market.  But then QE stopped, and banks began accumulating Treasury securities, thus reducing cash available for repo. 

According to a report from the Bank of International Settlements, the four largest banks in America own more than 50 percent of Treasury securities held by banks, and the largest 30 banks own 90 percent.  This made it difficult for banks to justify lending their cash because so much of their assets were tied up in longer maturity treasuries. Adding to the stress is a calendar effect.  Each year, a snapshot is taken of a bank for regulatory purposes, and they must have adequate cash on hand.  Banks could be preparing for this requirement in the weeks ahead and scrambling for more cash via the repo market.

Jerome Powell and his colleagues are standing by to make sure enough cash is on hand.  They have already started buying $60 billion of Treasuries each month.  They are not considering it QE, but since it’s helping satisfy regulators at the end of the year, we might call it quantitative pleasing.