By Michael S. Derby
(Reuters) -Federal Reserve liquidity facilities caught fire on Friday as month-end pressures pushed a key lending tool to a record level of usage.
The Fed’s Standing Repo Facility lent a total of $50.35 billion on Friday to eligible financial firms in two separate availabilities, the highest-ever usage since the tool was put in place in 2021 to provide fast loans collateralized with Treasury or mortgage bonds. At the same time, financial firms also parked a considerable amount of cash on Fed books, with the reverse repo facility seeing inflows of $51.8 billion.
The level of volatility in markets was not a surprise as month- and quarter-ends are often buffeted by volatility as firms move cash around for a variety of reasons, with some firms paring lending and related activities. On Friday, a number of key lending rates shot up well over the 4% top end of the fed funds target rate range.
“Ironically, the number of securities given to the Fed about equals the amount of cash received,” said Scott Skyrm, of money market trading firm Curvature Securities. “This was the first time the SRF functioned as designed.”
Analysts like Wrightson ICAP expect funding pressures to ease next week. And given how calendar dates traditionally influence money markets, SRF and reverse repo activity should ease relatively quickly.
The unusually heavy use of the Fed liquidity tools comes after the central bank said on Wednesday it would soon stop drawing cash out of markets. The central bank said that the drawdown of its balance sheet, called quantitative tightening, or QT, will end on December 1.
“Our long-stated plan has been to stop balance sheet runoff when reserves are somewhat above the level we judge consistent with ample reserve conditions,” Federal Reserve Chair Jerome Powell said at a press conference following the Federal Open Market Committee gathering. “Signs have clearly emerged that we have reached that standard in money markets,” he added.
ANXIETY OVER SRF USAGE
The Fed has shrunk its holdings from a peak of $9 trillion in the summer of 2022 to the current level of $6.6 trillion. It did so by allowing Treasury and mortgage bonds bought as part of COVID-19 pandemic stimulus to mature and not be replaced.
The Fed’s goal was to draw out enough liquidity to allow for firm control of the federal funds rate and normal volatility in short-term lending rates. Markets had expected QT to run into early next year. But a rise in money market rates, most notably an increase in the federal funds rate within its official range, was a signal to central bankers that they’d reached where they wanted to be.
“The decision to end asset runoff was one I supported,” said Dallas Fed President Lorie Logan, who spoke Friday. “Money market conditions indicate the Fed’s balance sheet is now much closer to a normal size, following the expansion in response to economic and financial stresses during the pandemic and the subsequent runoff.”
Logan, who managed the implementation of monetary policy before coming to the Dallas Fed, also said that she had some concerns about how the SRF fared over recent days. The tool was meant to be a shock absorber for liquidity that users would turn to when private lending rates were above what the Fed offered. But that has not been happening, and even in periods of high short-term rates, SRF usage has been light.
Logan said she was “disappointed” the SRF has gone largely untapped at times when it should have been an attractive source of funds.
“With rates averaging higher than they were just a few months ago, the likelihood of the SRF rate becoming economical on some days is higher,” Logan said, adding “dealers may now need to step up their readiness to access the SRF in response to rate moves.”
Speaking separately, Cleveland Fed chief Beth Hammack was also downbeat about how the SRF had fared.
“It is disappointing when we put tools out there” that the major banks said they wanted and they don’t really get used, Hammack said. When it comes to the future of the SRF and banks, “I’d like to see them take advantage of it to help redistribute reserves throughout the system.”
(Reporting by Michael S. Derby; Editing by Diane Craft and Andrea Ricci )
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