U.S. Federal Reserve Chairman Jerome Powell speaks during the “The Economic Outlook and Monetary Policy” panel discussion hosted by the Swiss Institute of International Studies at the University of Zurich in Zurich, Switzerland September 6, 2019.
Arnd Wiegmann | Reuters
Federal Reserve officials are continuing to look at ways to make sure funding pressures in the overnight lending market don’t cause a problem again.
At their October 29-30 meeting, Federal Open Market Committee members weighed several options ahead for keeping the repo market stable and maintaining the central bank’s key lending rate within its target range.
The discussions came about a month and a half after funding pressures sent repo rates soaring and the fed funds rate briefly above its target range. The repo market is considered the plumbing of the U.S. financial system as it is the place where banks go for the overnight loans they use to fund operations.
The minutes noted that Fed officials also met by videoconference on Oct. 10 to discuss a strategy.
One option that received considerable discussion was a so-called standing repo facility – essentially a mechanism where the Fed will step in whenever needed to supply banks with reserves in exchange for ultra-safe collateral like Treasury debt.
Pros and cons of standing repo
The standing repo idea is a popular one on Wall Street. But policymakers said they are not yet ready to make any decisions, instead deciding to continue to watch how market operations instituted since the September problems are working.
A standing repo “would likely provide substantial assurance of control over the federal funds rate, but use of the facility could become stigmatized, particularly if the rate was set at a relatively high level,” minutes from the October meeting stated.
“And by effectively standing ready to provide a form of liquidity on an as-needed basis, such a facility could increase the risk that some institutions may take on an undesirably high amount of liquidity risk,” the minutes said.
In addition to the standing repo, officials discussed “modestly sized, relatively frequent repo” operations that nonetheless would not be permanent.
There’s been some debate about how to see the operations the Fed has instituted to handle the repo issues, which were attributed to a high degree of Treasury auction settlements and corporate tax payments that drained liquidity from the system.
Fed officials have repeatedly emphasized that the efforts to expand the balance sheet, with the aim of increasing bank reserves, is not akin to the quantitative easing program used to stimulate the economy during and after the financial crisis.
However, markets have treated it to some extent as a “QE4” type of operation.
The balance sheet has expanded about 7.4% since the repo issues to near $4.1 trillion, while the S&P 500 has gained about 4.5%. Bank reserves, meanwhile, have grown little – just $11.6 billion since Sept. 11, or less than 1%.
Fed officials said they will continue to examine the issue.
Members “commented on the need to carefully evaluate these design choices to guard against the potential for moral hazard, stigma, disintermediation risk, or excessive volatility in the Federal Reserve’s balance sheet,” the minutes said.