NY Fed expects quarter-end money market dynamics to repeat

Money market conditions were relatively benign around year-end as rates were well-contained, according to the New York Federal Reserve. Overnight unsecured rates were stable with the effective federal funds rate (EFFR), a measure of the cost of borrowing overnight in the federal funds market, printing comfortably within the Federal Open Market Committee’s (FOMC’s) target range.

As widely expected, there was upward pressure on the secured overnight financing rate (SOFR) around year-end, but those pressures were smaller than at the September quarter-end and dissipated shortly after. Market commentary broadly pointed to the amount of advance preparation by market participants as helping to limit upward pressure on repo rates at year-end.

Given the incentives for some banks to limit the size of their balance sheets at year-end, there were fewer available private-market short-term investments, which, as expected, contributed to a temporary increase in reverse repo (RRP) facility use around year-end. Finally, year-end conditions in offshore dollar funding markets—such as the FX swaps market—also were benign, and correspondingly, use of the standing US dollar liquidity swap lines was relatively limited. 

Where Do Money Markets Stand Following Year-end?

Money market conditions normalized quickly as year-end pressures dissipated. The EFFR continued to print well within the FOMC’s target range and repo spreads returned to levels seen around the middle of December, before year-end effects began to influence market activity. Use of the ON RRP facility declined significantly in the days following the year-end. Currently, overnight repo rates are trading close to the ON RRP offering rate, indicating that the cut to the FOMC’s target range and the technical adjustment to the ON RRP offering rate in December have fully passed through to repo markets. 

Looking Ahead

Desk staff expect similar dynamics in money markets to play out around quarter-ends going forward. The re-emergence of temporary money market pressures around quarter-ends is unsurprising as the normalization of liquidity conditions progresses and marks a return to market behavior seen during the prior period of balance sheet runoff from 2017 to 2019 and before the expansion of the Fed’s balance sheet in response to the pandemic in 2020.

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