Rate Cuts and Funding Crunches

September 19, 2019

FED, Federal Reserve with interest rate cut concept, small cube block with alphabet building the word CUT next to Federal Reserve emblem on US Dollar banknote.


USBAM's CIO, Jim Palmer, comments on the September 18th FOMC meeting and repo operations.
Jim Palmer, Chief Investment Officer

While the Federal Open Market Committee (FOMC) met market expectations yesterday with a 25 basis point (bp) cut to the federal funds target range, the outlook for future easing seemed to skew less dovish than anticipated. Additional details include:

  • The federal funds target range was lowered 25 bps to 1.75% - 2.00%
  • The interest rate on excess reserves and the overnight repo rate were lowered 30 bps to 1.80% and 1.70%, respectively (the extra five bp cut was a clear effort to push down the effective funds rate closer to the mid-point of the target range)
  • The FOMC voted 7-3 for the policy change - the highest number of dissents since September 2016. Fed Bank Presidents Rosengren and George preferred to maintain the current target range while Fed President Bullard favored a 50 bp cut.
  • The Fed's Dot Plot median forecast is for no further rate cuts in 2019 or 2020. Also, no FOMC participant is forecasting a fed funds target range below 1.50% - 1.75%, implying only one additional 25 bp rate cut during this cycle. The forecasts bolster the case the FOMC is making mid-cycle adjustments rather than executing a long-term easing plan.
  • During his press conference, Chairman Powell downplayed concerns over the recent repo funding crunch and the need to expand bank reserves in the system. The Chairman did commit to further repo operations as needed for the foreseeable future to manage ongoing funding risks.

The meeting comes on the heels of some of the greatest disruption seen in the repo funding markets since the financial crisis. On September 17th, repo rates spiked 300 bps above the Fed's target range on a combination of factors:

  • Mid-month corporate tax payments drained reserves from the banking system and money market funds
  • $54B in U.S. Treasury coupon bonds settled on September 16th - a portion of which landed on dealer balance sheets and needed to be financed in the repo markets
  • Street chatter indicated Saudi Arabia withdrew billions in cash from the system to help support its economy after the attacks on its oil production facilities
  • September has seen $129B in corporate debt issuance to date - a portion of which has almost certainly been funded with cash holdings, further diminishing available repo funding
  • Lower bank reserves in the financial system have reduced the ability of banks to absorb demand for repo funding

To be clear: USBAM believes the jump in repo rates is not a symptom of financial trauma where counterparties are refusing to lend to each other, but instead is technically driven by the unusual confluence of factors listed above.

To combat the dislocation in repo markets, on the 17th the Federal Reserve Bank of New York conducted the first open market repo operations in almost a decade, offering up to $75B at a minimum bid rate of 2.10% to help bring funding rates closer to the Fed's target range. Dealers took down $53.2B of Fed repo financing on Tuesday and the full $75B on Wednesday and Thursday. The program calmed funding markets, as we saw repos trade today at 1.85% - 1.90%, right near the mid-point of the Fed's target range. We anticipate these operations will be conducted as necessary going forward.

Given the dislocations seen in the funding markets, it was surprising and disappointing to see the FOMC decline to allow the Fed's balance sheet and bank reserves to organically grow. I think policymakers missed a needed and straight-forward opportunity to ease financial conditions without spending rate cut ammunition. However, Mr. Powell's observation the FOMC will "learn a lot in next six weeks" on reserves suggests a policy change on balance sheet growth may be on deck for the October meeting.

No FOMC meeting can go by without President Trump subtly weighing in. This time around we got, "Jay Powell and the Federal Reserve Fail Again. No ‘guts,' no sense, no vision! A terrible communicator!" Reading between the lines, Mr. Trump seemed unimpressed with the FOMC's actions. For his part, Mr. Powell declined to comment on the President's remarks - but to me, he looked a little ticked off when a reporter relayed the President's tweet.



Bloomberg, U.S. IG Issuance: Market Takes a Breather With Two Deals Pricing, September 17, 2019

Federal Reserve, FOMC Statement, projection materials and press conference, September 18, 2019

Federal Reserve Bank of New York, Statement Regarding Repurchase Operation, September 17, 2019

Twitter, @realDonaldTrump

United States Treasury, Calculated New Cash/Pay Down Amounts, www.treasurydirect.gov