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Money Market Investors Embrace a Calmer Repo Market
Still fresh on money market investors' minds is the repo market seizure back in September that temporarily drove rates to as high as 10%. However, investors have embraced the Federal Reserve's forceful response. Peter Yi, director of short duration fixed income, explains.
- Mitigating Disruption
- Controlling Overnight Rates
- Fed Proving Up to Task
Still fresh on money market investors' minds is the repo market seizure back in September that temporarily drove rates to as high as 10%. However, investors have embraced the Federal Reserve's forceful response. Let's look at what the Fed has done and what investors should expect.
Money market investors viewed year-end to be a significant milestone to test the Federal Reserve's preparation for controlling the repo market, a key overnight financing market for government securities that the Fed uses to control money supply. The Fed reassured investors with almost half a trillion in new liquidity to address any dislocations at year-end. The Fed clearly demonstrated that they can inject substantial liquidity into the financial markets using various temporary repo facilities designed for primary dealers. Further, the Fed committed to purchasing $60 billion dollars a month in U.S. Treasury bills, expanding its balance sheet and increasing the amount of excess reserves in the financial system.
The Fed will likely sunset these temporary repo operations as the size of its balance sheet increases with its Treasury bill purchases. While the Fed debates whether it should adopt a permanent liquidity facility, we believe it's unlikely in the near future. The cumulative Treasury bill purchases should eventually create enough ample reserves in the financial system to absorb potential dislocations in overnight rates and the repo market. Last week, the Fed's open market committee kept the short-term interest rate target range unchanged in January, as expected. However, for money market investors, there were two small technical adjustments. The Fed increased by 5 basis points the interest rate it pays on excess reserves and also its reverse repo facility. We think the Fed will continue to tweak its operational model for more precision in its ability to control overnight rates.
Chairman Jerome Powell has said the Fed cannot smooth out every instance where the repo rate is significantly outside of the Fed's target range. But we think investors can feel more confident that the Fed is up to the task when the money markets show signs of disruption.
Peter Yi, CFA
Director, Short Duration Fixed Income and Head of Taxable Credit Research
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