This post was originally published on this site
By most accounts the Federal Reserve has moved aggressively to prevent the recurrence of strains in the multi-trillion dollar repo market, where banks and hedge funds borrow and lend funds on a short-term basis.
Yet for those who aren’t primary dealers and thus don’t benefit from the U.S. central bank’s regular injections of liquidity, the end of year could prove a treacherous period when short-term funding turns scarce according to market participants.
Banks across Wall Street typically pull back their lending at the end of the quarterly and yearly period to avoid receiving steep regulatory surcharges that demand too-big-to-fail financial institutions carry additional capital on their balance sheets.
“Current open market operations in their current form are still not getting to those who still need term funding,” said Nick Maroutsos, co-head of global bonds at Janus Henderson Investors, referring to repo funding contracts that extend beyond a day and which have been deployed by the Fed to help market participants get past the year-end hurdle. “The money is not getting where it needs to go,” he said.
Since September, the Fed has halted the shrinking of its balance sheet and has lent out billions of U.S. dollars through open market operations, parceling out cash in return for collateral in the form of U.S. Treasurys. These injections have helped keep a ceiling on overnight lending rates for the repo market which surged three months ago and prompted the central bank’s interventions.
But of the members of the Fixed Income Clearing Corporation, a hub for repo traders that handles the settlement and delivery of Treasurys and government-sponsored mortgage bonds, more than 70 financial institutions don’t have direct access to the Fed’s regular repo operations, said Maroutsos.
See: The repo market is ‘broken’ and Fed injections are not a lasting solution, market pros warn
That means the 24 primary dealers, banks that trade directly with the Fed, are responsible for ensuring the cash they receive from the Fed are circulated across the rest of the repo universe.
Banks, however, are reluctant to part with their reserves. Returns from lending out funds through overnight repo markets are meager and post 2208 crisis capital requirements have encouraged banks to hoard reserves rather than distributing them to cash-starved market participants.
“There’s not really a financial incentive from an interest rate perspective” for banks to lend their cash to others, said Tim Magnusson, senior portfolio manager at Garda Capital Partners, a fixed-income hedge fund.
The largest banks that still remain active players in repo lending have also been held back by the huge amount of U.S. Treasurys they carry on their balance sheets, according to the Bank of International Settlements. With their capacity to distribute reserves weakened, the key pipelines woven through the repo market remain clogged, analysts said.
Read: JPMorgan anticipates ‘disorderly’ year-end funding pressures again as banks retrench
Still, not all those outside of the select primary dealer community would necessarily suffer if short-term funding markets seized up again at the end of this year.
The funds that banks are lending are going to clients which also do a lot of other business with major banks, providing an incentive for them to ensure liquidity, said Scott Skyrm, executive vice president at Curvature Securities. “Their clients right now are those that have a lot of dual businesses at the bank. If banks cut back on their repo funding for their clients, their clients are not going to do future business with them,” he said.
Analysts nevertheless have called for a standing fixed-rate repo facility as an important fix that would widen the range of financial institutions that could borrow funds from the U.S. central bank.
The Fed has “put out most of the forest fire from September, but there are still embers burning on the ground,” said Aaron Stearns, co-head of AVM Solutions, a repo trading firm, in written comments.
