UNITED STATES - For the first time in more than a decade, the Federal Reserve injected cash into money markets Tuesday to pull down interest rates and said it would do so again Wednesday after technical factors led to a sudden shortfall of cash.
The pressures relate to shortages of funds banks face resulting from an increase in federal borrowing and the central bank’s decision to shrink the size of its securities holdings in recent years. It reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.
Separately, the Fed’s rate-setting committee began a two-day policy meeting Tuesday at which officials are likely to lower the federal-funds range by a quarter-percentage point to cushion the economy from a global slowdown, a decision unrelated to the funding-market strains.
The federal-funds rate, a benchmark that influences borrowing costs throughout the financial system, rose to 2.25% on Monday, from 2.14% Friday. The Fed seeks to keep the rate in a target range between 2% and 2.25%. Bids in the fed-funds market reached as high as 5% early Tuesday, according to traders, well above the band.
The New York Fed moved Tuesday morning to inject $53 billion into the banking system through transactions known as repurchase agreements, or repos. The bank said Tuesday afternoon it would inject up to $75 billion more on Wednesday morning, but many in the market were looking beyond that decision. “The market will be waiting to see if the Fed makes this a more permanent part of the playbook,” said Beth Hammack, the Goldman Sachs Group Inc. treasurer.
Fed policy makers set their target range to influence a suite of short-term rates at which banks lend to each other in overnight markets—but those rates are ultimately determined by the markets. If various operations in the markets fail, the fed-funds rate can deviate significantly from the target.
In the short run this likely affects only market participants who borrow in the overnight markets, but if the strains last long enough it can affect the rates other businesses and consumers pay.
Such deviations also undercut the Fed’s ability to keep the economic expansion on track through monetary policy, such as by lowering rates to provide a boost and raising them to prevent the economy from overheating.
The New York Fed hasn’t had to intervene in money markets since 2008 because during and after the financial crisis, the Fed flooded the financial system with reserves—the money banks hold at the Fed. It did this by buying hundreds of billions of dollars of Treasurys and mortgage-backed securities to spur growth after cutting interest rates to nearly zero.
Reserves over the last five years have been declining, after the Fed stopped increasing its securities holdings and later, in 2017, after the Fed began shrinking the holdings. Reserves have fallen to less than $1.5 trillion last week from a peak of $2.8 trillion.
The Fed stopped shrinking its asset holdings last month, but because other Fed liabilities such as currency in circulation and the Treasury’s general financing account are rising, reserves are likely to grind lower in the weeks and months ahead.
In addition, brokers who buy and sell Treasurys have more securities on their balance sheets due to increased government-bond sales to finance rising government deficits.