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Fed offsets expected liquidity pressures in repo markets

The Federal Reserve Bank of New York managed to flush enough cash into the overnight repurchase, or repo, market Dec. 16 to offset an expected liquidity crunch.

As companies prepared for the corporate tax payment deadline and U.S. Treasury securities hit a settlement date that day, analysts projected that repo rates would spike in a similar fashion to the surge seen in mid-September. Yet, the regulator's injection appeared to have paid off, as the effective federal fund rate ticked up 1 basis point and remained within its target range of 1.50% to 1.75%. The New York Fed conducted two separate operations Dec. 16, including a same-day deal of $36.4 billion and a 32-day operation of $50 billion.

"December 16 was a far cry from three months ago in terms of secured market volatility," wrote BMO Capital Markets' Jon Hill, vice president of U.S. rates strategy; Ian Lyngen, head of U.S. rates strategy; and Benjamin Jeffery, rates strategy associate; in a Dec. 16 research report. The analysts pointed out that the regulatory environment was considerably different in September when the third quarter was ending, as well.

Repo markets, where banks, hedge funds and other financial firms borrow and lend cash overnight in exchange for collateral, have gained newfound attention in recent months after a rush of volatility in September caught many market participants and regulators off guard.

U.S. regulators within the Fed have taken a number of steps in the ensuing months to ensure a spike of that sort does not occur again. The Federal Reserve Bank of New York recently revealed that it was ramping up its liquidity injections at the end of the year, upping its overnight repo offering to at least $150 billion on Dec. 31 and Jan. 2, 2020. The New York Fed plans to also offer a $75 billion repo Dec. 30 that will settle the next day.

"Flooding the system with cash continues to put significant downward pressure on rates — at least before the year-end turn," the BMO analysts wrote.