NY Fed Doubles-Down on Repo Intervention as Bank Cash Crisis Rattles Markets

The New York branch of the U.S. Federal Reserve added billions more in liquidity to gummed-up intrabank lending markets Wednesday, following the first intervention in more than a decade only yesterday, as a worrying spike in overnight borrowing costs continues to perplex investors and complicate today's Fed rate decision.

The New York Fed offered $75 billion in cash to broader markets, in exchange for eligible collateral such as U.S. Treasury bonds or mortgage-backed securities, in order to hold the Fed's key rate inside its target range of between 2% and 2.25%. It accepted its full allotment, even as bids totaled $80 billion, lowing the range from 2.6% to 3% prior to the operation to 2.25% to 2.6% immediately afterwards.

The New York Fed was forced yesterday to inject $53.2 billion after overnight borrowing costs surged close to 10%, thanks in part to the hefty burden of primary dealers in the Fed system taking down nearly $45 billion each day in gross U.S. Treasury bond issuance, and reducing spare cash -- known as excess reserves -- at the same time. In fact, excess reserves have fallen by $171 billion so far this year, according to Fed data, and are down $1.4 trillion from 2014 levels.

Nonetheless, the repeat overnight repo operation later today -- only the second in ten years -- will add to market jitters as to what Powell and his colleagues are likely to say about future rate hikes, and the unwinding of the Fed's $3.8 trillion balance sheet, in the months ahead.

"We think that the culprit is the scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity," said TD Securities head of global rate strategy Priya Misra. "Reserves have been declining since 2014 and we expect them to decline further as Treasury's cash balance increases and currency in circulation grows."

"Ultimately, we believe the Fed needs to start growing the asset side of its balance sheet to prevent the decline in excess reserves," he added. " If the Fed views the repo spikes as a sign that reserves may have already become scarce (at least at a certain point), they may decide to begin buying Treasuries to keep pace with the growth of currency in circulation."

With the U.S. budget deficit topping the $1 trillion mark for only the second time on record this year, as the Treasury ramps-up borrowing to pay for the massive $1.5 trillion in Republican-led tax cuts passed in late 2017, the 24 primary dealers in the Federal Reserve system have been taking down some $45 billion gross Treasury bond issuance each and every trading day this year.

Furthermore, with the suspension of the debt ceiling earlier this summer, Treasury borrowing projections estimate a further $814 billion in new bonds will need to be absorbed by the market between now and the end of the year, placing even more stress on the level of excess reserves in the Fed system.

DoubleLine Capital's Jeffrey Gundlach told Reuters Tuesday that the repo market 'squeeze' would likely drive the Fed towards further …

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