The US Federal Reserve’s unprecedented 10-month intervention in short-term borrowing markets has been wound down, after the central bank successfully tamed volatile funding costs that had threatened to cause disruption across the financial system.
The volume of the Fed’s operations in the repo market, where investors swap high-quality collateral like US Treasuries for cash, fell to zero this week after the central bank’s latest 28-day loan matured on Tuesday, taking a final $53.2bn out of the market.
Scott Skyrm, a repo trader at Curvature Securities, called it an “important” moment signalling a return to normalcy in the market.
The Fed first stepped in aggressively when a cash crunch sent overnight borrowing costs surging last September. Repo market participants said banks’ excess reserves had dwindled to the point that they were reluctant to make the overnight and short-term loans that underpin significant swaths of financial activity.
The central bank then scaled up its interventions when coronavirus disrupted markets. At one point, it was offering more than $5tn in short-term loans — although even during the worst of the volatility in mid-March, take-up peaked at $495.7bn, according to analysts.
The Fed’s repo activities have since been dwarfed by its other emergency measures, including the resumption of large-scale quantitative easing and the launch of multiple emergency facilities for corporate bond markets, US local governments and other markets.
“The fact that the Fed is willing to slowly and incrementally pull back indicates both that funding markets have normalised substantially since March and that in the long run the Fed wants to not have a larger footprint than they need to,” said Jon Hill, an interest rates strategist at BMO Capital Markets.
The recent decline in the Fed’s repo operations followed a technical tweak to the terms of its lending. Last month, the Fed slightly raised its prices for both its overnight and longer-term loans.
It now charges a minimum rate of 0.05 percentage points above the interest on excess reserves that banks hold in their accounts with the Fed for overnight borrowing, and slightly more for the 28-day loans. It cited “substantial improvements” in funding market conditions as justification for the move.
The cost to borrow cash overnight in the repo market now hovers around 0.13 per cent.
Mr Hill said the decision was a purposeful one to “disincentivise” the use of the Fed’s operations, given that market rates to borrow from other sources are slightly lower.
“They want this repo facility to be a backstop, rather than something that is used every day,” he said. “They only want it used at moments when the [private market] is no longer functioning well.”