Facing Quarter-End Pressures: Understanding the Repo Market and Federal Reserve Tools
November 12, 2024
Roberto Perli, Manager of the System Open Market Account
When market lending rates start to drift higher relative to our administered rates, it is natural to ask what role the Fed’s facilities play in maintaining rate control and money market functioning. Recent events have focused market attention on our Standing Repo Facility (SRF), and I would like to take some time to discuss it here.
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Is the SRF designed to be an effective backstop for all three segments of the repo market? The answer is a clear no.
For one, borrowers in the dealer-to-client segment of the repo market (again, mostly hedge funds) do not have direct access to the SRF. Therefore, the SRF cannot be expected to directly dampen rate pressures in that segment.
Primary dealers, on the other hand, do have access to the SRF. In principle, they should be incentivized to use the SRF whenever market rates in the interdealer or dealer-to-client segments are higher than the SRF minimum bid rate. It is important to bear in mind, however, that the interest rate paid is not the only cost of engaging in repo transactions; there are other costs associated with operational overhead, regulatory constraints, and internal risk limits that are very important. For example, a dealer that borrows from other dealers in the interdealer market and lends in the dealer-to-client market generally faces little operational overhead because transactions in both of those markets settle in the morning, as I just noted. Instead, a dealer that borrows in the tri-party segment and lends elsewhere faces higher operational overhead because the borrowing portion of its transaction settles in the afternoon instead of the morning. Further, almost all interdealer activity as well as a sizeable fraction of client-facing lending and borrowing is centrally cleared. Cleared positions can be netted down when measuring the size of dealer balance sheets, which reduces the costs associated with those trades relative to uncleared positions and increases overall gross capacity.
The SRF, because it is conducted over the tri-party platform, settles in the afternoon and is thus not lined up with the early-morning nature of most interdealer and dealer-to-client activity. It is also not centrally cleared, and therefore cannot be netted against other positions. There is, of course, a price differential at which the SRF would be more attractive considering these costs, but this difference, which is understood to be substantial, explains why dealers may not turn to the SRF even when market rates are higher than the SRF rate.
The full speech is available at https://www.newyorkfed.org/newsevents/speeches/2024/per241112
The slide deck is available at https://www.newyorkfed.org/medialibrary/media/newsevents/speeches/2024/Understanding-the-Repo-Market-and-Federal-Reserve-Tools-Slides.pdf