Bazooka? Fed jacks up repo operations

The Federal Reserve of New York

The Federal Reserve of New York

Yields move in the opposite direction of prices. The central banks are facing a crisis only partly responsive to the medicine they can provide.

On Thursday, the Federal Reserve noticed the market jamming up and chose to step in with an infusion of cash available to banks.

Guy LeBas, chief fixed income strategist at Janney, said that many large banks are saddled with huge holdings of Treasury securities and likely want to unload them to free up cash for their corporate clients. Dealers - the banks that buy and sell under all conditions - didn't have robust enough balance sheets to meet the demand from buyers and sellers of Treasurys.

Some of what the Fed is doing could be seen as easing the way to a restart of bond buying in earnest, but that is creating ambiguity for markets, according to Seth Carpenter, an economist at UBS.

Marcel Fratscher, head of the German Institute for Economic Research in Berlin, told the dpa news agency that "unlike during the global financial crisis, the central banks will only be able to help a little in combating the economic damage from the coronavirus".

Central banks' primary tools (lower interest rates and easier access to credit) are inadequate to deal with a crisis caused by a pandemic that has scared consumers away from traveling, shopping, or gathering in groups. Those traders have also helped the USA government digest a large supply of Treasury securities amid ballooning budget deficits.

On Thursday afternoon, the Fed attempted to alleviate strains by offering up to $1.5 trillion in short-term loans called repurchase agreements, or repo, to financial institutions. The lending won't all be cumulative. This made banks less willing to lend to other banks, brokers and hedge funds. Since October, the Fed has been buying $20 billion in securities of varying maturities and $60 billion concentrated in bills, which have maturities of one year or less.

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The market for the 10-year bond affects the economy overall because it influences the rates for home loans, credit cards and other interest rates in the US. Because investors are confident the USA government would never default on its debt, the bonds issued by the government are used to price every other asset.

Disruptions to funding that first appeared Wednesday and continued Friday suggested the Fed's promise on Thursday to provide essentially unlimited amounts of short-term loans secured by government debt hadn't fully resolved issues plaguing the Treasury market.

Given the scope of the Fed's action on Thursday, many economists now expect the Fed to cut its benchmark interest rate by a full percentage point, to almost zero, at its policy meeting next week. It may even launch a large bond-buying program meant to further lower interest rates.

In a sign of growing funding strains in the banking system, indicators of the difference between the rate at which banks lend to each other and the Fed's interest rate increased to the highest level since the tail end of the 2008-09 financial crisis.

But Fed officials have also acknowledged there are limits to how much monetary policy can help stabilize confidence, and analysts have warned that markets could remain volatile until public testing for the coronavirus has revealed the full extent of its spread in the U.S. But Christine Lagarde, president of the European Central Bank, said monetary policy could not do it alone and called for a "decisive and decisive, quot; response from governments". The coronavirus presents them with a very different challenge. The central banks in the USA, the eurozone, Canada and Britain have all deployed stimulus. The Bank of Japan is indicating that it is ready to act and the monetary authorities in Australia, Indonesia and Malaysia have reduced the rates.

Authorities are putting major economies, businesses and travel on lock down around the world, casting a shadow over prospects for the global economy. Consumers are starting to cut back on their spending in the USA and around the world.

Europe's top monetary authority did not cut rates as investors expected, evidence that monetary policy is running out of ammunition at already very low rates. The central bank already cut rates by a half point in an emergency move last week.

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