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15 Oct 2019

US Repo Rate Surge and Fed QE

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Fed is buying US treasury bills to shore up reserves that had fallen due to its balance sheet normalisation.

author dp
C S S Nikhil Bhargav

Fed is buying US treasury bills to shore up reserves that had fallen due to its balance sheet normalisation. The low reserves had resulted in a sudden spurt in money market rates. The Fed buying treasury bills is strictly not QE but is also actually QE as its prints money to buy the securities.

Federal Reserve injected USD 203 billion during the month of September 2019 into the US financial system with a move it has not used in more than a decade to calm surging money market rates.  Overnight repo rates had touched highest levels of 10%. In the overnight repo operation, banks borrow cash from the Fed using Treasuries and other securities as collateral. Repo operations have been rare in recent years because banks have had ample supply of liquidity for daily operations. However, due to quarterly corporate tax payments and settlement of USD 78 billion Treasury sales had sucked out liquidity in US markets.

The surge in borrowing costs, which banks pay to raise cash to fund their trades and loans, was mainly  due to Fed’s normalisation of its humongous balance sheet. Bank reserves have declined by USD 900 billion since 2017, which is largely due to normalisation of Fed’s balance sheet.

Main reason for Fed to intervene in overnight repo market is to bring down surging rates to normalcy or with in target range of 1.75%-2%. In the month of September, Federal Reserve committee has decided to lower repo rate by 25 bps to 1.75%-2% as inflation remains subdued amid heightened concerns about the economic outlook and ongoing trade tensions with China. The US annual inflation rate was unchanged at 1.7% in September 2019, slightly below market consensus of 1.8%, as a pickup in food inflation was offset by a further decline in energy prices.

 

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