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The Fed loses control of its interest rate on the day of the big decision – "It just doesn't look right"



Jerome Powell, Chairman of the United States Federal Reserve, awaits the start of a House Financial Services Committee hearing in Washington, D.C., on Wednesday, July 10, 2019.

Andrew Harrer | Bloomberg | Getty Images

Since the Fed met to consider reducing interest rates, it lost control of the reference interest rate itself.

It was a rough week in the overnight financing market where interest rates temporarily jumped to as high as 9 and 1

0% for some transactions on Monday and Tuesday. The market is considered to be a major pipeline for financial markets, where banks that need cash short-term come to finance themselves.

The odd rate hike forces the Fed to enter into money market operations aimed at controlling them, ie. and after Wednesday's second operation, it appears to have calmed the market.

In a rare move, the Fed's own fund-raised target rate for the fund rose to 2.3% on Tuesday, above the target set at the last meeting in July. The target range is 2 to 2.25% and the amount of funds was 2.25% on Monday.

The second rate the Fed observes, the secured overnight financing rate, or SOFR, reached 5.25% on Tuesday from 2.43%. That's the average rate of $ 1.2 trillion in short-term financial transactions that occurred on Tuesday. SOFR affects floating interest rates on approximately $ 285 billion in unpaid corporate and other loans.

Fed Chairman Jerome Powell is expected to face questions on the matter when he briefs the press after 2:00 p.m. decision for the course on Wednesday afternoon. The Federal Reserve is expected to reduce its target fundraising rate by a quarter point to 1.75 to 2% later.

"That just doesn't look right. You set your goal. You are the almighty Fed. You are supposed to control it and you can't on Fed Day. It looks bad. It was a tough start for Powell, "says Michael Schumacher, director of Wales Fargo.

Schumacher and other strategists said the Fed's two operations on Tuesday and Wednesday seemed to calm the market so far, but the question is why in the first place there has been a wild drop in rates, and strategists say it seems to be the result of a monetary crisis, not for now, the credit crunch.

What is a repo?

problem in the financial system Strategists direct the problem to a number of factors, incl The Fed's own balance sheet decline, which removed some of its liquidity from the market, and changes in post-financial crisis rules that forced banks to hold more capital, reducing their ability to offer repo.

There seemed to be a perfect storm on Monday. Corporations sought dollars for quarterly tax payments, and the Treasury also issued large amounts of bills, which reduced liquidity. There has also been speculation that an attack on Saudi Aramko, which took half of its off-line production, may have stimulated demand, as oil was saved and investors feared conflict in the Middle East.

On Tuesday, the Fed received $ 75 billion of the $ 80.5 billion bids submitted in its overnight repo operation after accepting $ 53 billion on Monday. The repo rate was quoted from 2.25 to 2.60% after Tuesday's surgery of a range that was above 3% just before it. This percentage on Tuesday temporarily reached a high rate of 9%.

"They are working on this problem with the repo. Work in progress. They are doing very well. They take it a lot, "said Ralph Axel, an interest strategist at Bank of America Merrill Lynch.

Strategists said the Fed is likely to cut interest rates on excess reserves at its meeting Wednesday. The rate is currently 2.10% and Schumacher said it could be reduced by the Fed to 1.80% when it cut interest rates on Wednesday. This could help the Fed maintain better control over the funds it supplies.

"Overall, the whole repo jump is also decreasing. So you'd expect power supplies to probably print a little lower tomorrow, but it might not be enough to be in the group," Axel said.

The Fed must turn to Wednesday

Axel said the market would seek answers from the Federal Reserve on how to resolve the issue permanently, especially as the September 30 quarter approaches, when there is more funding pressure, as alternative financing usually shrinks at the end of the quarter and the repo is in high demand

"Does the Fed continue to transfer the $ 75 billion facility for the rest of the month? Or is it moving to permanent operations?" said Axel. "September 30 is another potential interest rate hotspot. A big problem is making sure they control the rates on September 30 to make sure they stay in their group,"

Axel said he believed the rapid breakdown came just as the Treasury focused on increasing its own cash reserves, which went from $ 183 billion a week ago on Wednesday to $ 298 billion on Monday.

"After the 2011 debt crisis, the Treasury decided to maintain a very large cash balance." – said Axel, adding that the Ministry of Finance did not find it necessary earlier. He said the Treasury has decided that it is in the public interest to have a large cash balance to absorb any problems in the cashier's funding market.

Axel stated that the funds were drawn from excess reserves that the Fed controls, and that it was reducing money supply, "Therefore, to compensate for this and to resolve problems that were in the financial markets, the Fed added money to cash through open market operations, which is the traditional role of New York based feeders, "he said.


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