Susan Hill, CFA
Senior Vice President
Senior Portfolio Manager, Head of Government Liquidity Group
When rates on the typically steady overnight repurchase agreements behave like the stock market, as they did yesterday and this morning, even the broad market pays attention. But despite the flashing red lights, this increase in short-term rates is being driven by technical factors rather than credit concerns.
A confluence of factors, chiefly the deadline for corporate quarterly tax payments and the settlement of $54 billion of net new U.S. Treasury supply, led to funding pressures over the past few trading sessions. That pushed rates on repo transactions with Treasury and agency collateral to an eye-popping 5% today for the general collateral type of trades done by money market funds. The volatility has been furthered by reserve balances at the Fed that have declined to a level that may make it more difficult for the Fed to maintain control over the level of short-term interest rates.
This event is unusual, but the surge—and the resulting increase in yields on certain money funds—is not a credit-driven event.
The Fed acted quickly this morning to address this perceived reserve shortage through operations in the market that provide liquidity, and may announce new tools at the Federal Open Market Committee (FOMC) meeting tomorrow to address the market dislocation. In a separate action, we also expect the FOMC to lower the fed funds target range to 1.75% to 2%.