It may be months before Federal Reserve officials are ready to take any action on interest rates, so traders are focusing on something else that ordinarily gets less attention: The undercarriage, or plumbing, of funding markets, where things could start to go awry in certain scenarios and undermine confidence in the U.S. banking system.
Large financial firms like money-market funds and banks use overnight programs such as the Fed’s reverse repurchase facility to park large amounts of cash on a short-term basis. They do so via transactions known as reverse repos, which involve the brief exchange of cash for high-quality securities like Treasurys that are on the central bank’s balance sheet, temporarily reducing the supply of reserve balances in the banking system. This plumbing is what helps the Federal Reserve keep its main policy rate target in check and allows markets to function more smoothly. It’s part of a process that typically runs quietly in the background of financial markets, but arguably could end up becoming as disruptive as it was in September 2019 when volatility gripped the overnight funding market amid a big decline in bank reserves. The year 2019 “was one example of what could happen again, when banks ran into reserve scarcity, and it was a situation that was unfolding very rapidly and proved to be very disruptive for the banking system,” said economist Derek Tang of Monetary Policy Analytics in Washington. “It was quite hard for Fed officials to figure out what to do in real time. If it happens again, they might be better prepared, but it is unclear if any of their actions would be enough to offset the risk.“At the moment, usage of the reverse-repo facility is dwindling, with the amount of daily balances shrinking to $519.7 billion as of Tuesday from as high as $2.55 trillion on Dec. 30, 2022. The fear is t …
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Large financial firms like money-market funds and banks use overnight programs such as the Fed’s reverse repurchase facility to park large amounts of cash on a short-term basis. They do so via transactions known as reverse repos, which involve the brief exchange of cash for high-quality securities like Treasurys that are on the central bank’s balance sheet, temporarily reducing the supply of reserve balances in the banking system. This plumbing is what helps the Federal Reserve keep its main policy rate target in check and allows markets to function more smoothly. It’s part of a process that typically runs quietly in the background of financial markets, but arguably could end up becoming as disruptive as it was in September 2019 when volatility gripped the overnight funding market amid a big decline in bank reserves. The year 2019 “was one example of what could happen again, when banks ran into reserve scarcity, and it was a situation that was unfolding very rapidly and proved to be very disruptive for the banking system,” said economist Derek Tang of Monetary Policy Analytics in Washington. “It was quite hard for Fed officials to figure out what to do in real time. If it happens again, they might be better prepared, but it is unclear if any of their actions would be enough to offset the risk.“At the moment, usage of the reverse-repo facility is dwindling, with the amount of daily balances shrinking to $519.7 billion as of Tuesday from as high as $2.55 trillion on Dec. 30, 2022. The fear is t …nnDiscussion:nn” ai_name=”RocketNews AI: ” start_sentence=”Can I tell you more about this article?” text_input_placeholder=”Type ‘Yes'”]