The Fed loses control of the interest rate

The Fed loses control of the interest rate

As the Federal Reserve was meeting to discuss rate cuts, it lost control of the benchmark rate it manages.

It was a tough week in the finance market overnight, with interest rates temporarily rising to 10% for some transactions on Monday and Tuesday. The market is the main plumbing of financial markets, where banks that need short-term funds come to finance themselves.

The sudden rise in interest rates forced the Federal Reserve to engage in money market operations aimed at curbing them, and after the second operation on Wednesday morning appeared to have calmed the market.

In a rare move, the benchmark federal funds rate rose to 2.3% on Tuesday, higher than the target range when it cut interest rates at its last meeting in July. The target range is 2% to 2.25% and the funds rate was at 2.25% on Monday.

The rate that the Fed watches, the secured overnight funding rate, rose 5.25% on Tuesday from 2.43%. This is the average price of $1.2 trillion in short-term financing transactions that occurred on Tuesday. This affects floating interest rates on about $285 billion outstanding in corporate and other loans.

Fed Chairman Jerome Powell is expected to face questions on the issue when he appears on the press, after 2pm for the central bank. The Fed is expected to cut the federal funds target rate by a quarter point to 1.75% to 2%.

Wells Fargo, director of price strategy, said that “This just doesn’t look good. You set your target. You’re the all-powerful Fed. You’re supposed to control it and you can’t on Fed day. It looks bad. This has been a tough run for Powell.”

Schumacher and other strategists said the Fed’s operations on Tuesday and Wednesday appeared to have calmed the market for now, but the question is why interest rate rises occurred in the first place. Strategists say it appears to be the result of a monetary crisis, not right now because of the credit crisis.

But anxiety, if it persists, could give a fundamental problem to the financial system. Strategists comment on the problem on a number of factors including the Fed’s reduction in its balance sheet, which removed some liquidity from the market, as well as changes in rules after the financial crisis, which required banks to retain more capital and reduce their ability to offer repo. Repo is an exchange of collateral such as treasury bills in cash.

On Monday, there was a storm in the market which caused a shortage of cash. Companies were seeking dollars for quarterly tax payments, and the Treasury also issued a large amount of bills, reducing liquidity. There has also been speculation that the attack on Saudi Aramco, which halted production by half of the production line, may be driving demand as oil rises and fear of conflict in the Middle East.

The Federal Reserve on Tuesday accepted $75 billion from $80.5 billion in bids in overnight repurchase, after accepting $53 billion on Monday. The repo rate was set at 2.25% to 2.60% after Tuesday’s run from a range that was even higher at 3%, just before that. This rate on Tuesday temporarily stood at 9%.

“They’re working on this repo problem,” said Ralph Axel, interest rate strategist at Bank of America Merrill Lynch. ” It’s a work in progress. They’re doing very well. They pretty much got it under control.”

The Fed is likely to cut interest rates on excess reserves at its meeting on Wednesday, strategists said. This rate is currently at 2.10%, and Schumacher said it may be cut by the Federal Reserve to 1.80% on Wednesday. This could help the central bank maintain better control over federal funds.

“Generally this whole repo spike is declining, too. So you would expect fed funds to probably print a little bit lower tomorrow, but it may not be enough to be within the band,” said specialists.

Drew Matus, chief market strategist at MetLife Investment Management, said Powell’s briefing could be very difficult. He stated that Powell will have to answer questions consistently, as repo is not the easiest topic for most people to understand, even for the Fed chairman. It’s really a specialized area on Wall Street. He’ll have to respond in a way that reassures people, which might make it a tough press conference.

Matus said the pressure of short-term funding may have been the result of a number of events, including tax payment day, but he and others pointed out that this does not usually happen on tax day. ” The repo market that we’re thinking of, the pre-crisis repo market of 2008 doesn’t exist any more. It’s a different market with different rules for banks and primary dealers”.