The Federal Reserve Bank of New York was ready to address recent money market stresses, and its actions to tamp down volatility were successful, New York Fed President John Williams said Sept. 23.
Williams pushed back against concerns that the Fed was unprepared for recent volatility in short-term borrowing markets after rates spiked early last week and the Fed's benchmark interest rate breached its 25-basis-point target range for a day.
The New York Fed stepped in with repo purchases starting Sept. 17 to provide temporary liquidity to money markets and bring rates back down to more normal levels. It also announced it will continue with its repo operations in the coming days to ensure rates do not jump back up.
The purchases "had the desired effect of reducing strains in markets" and nudging down short-term rates, Williams said in a speech at the New York Fed's U.S. Treasury Market Conference.
"This episode reminds us all of the importance of having well-functioning markets and the vital role that the Federal Reserve plays in supplying liquidity to the system when markets are under stress," Williams said. "We were prepared for such an event, acted quickly and appropriately, and our actions were successful."
Analysts attributed much of the lack of liquidity to a corporate tax payment deadline and a larger-than-usual issuance of Treasury securities, both of which led to bank reserves declining as money flowed to the Treasury Department. The Fed's earlier effort to decrease its $3.8 trillion balance sheet contributed to the liquidity shortage, as the quantitative tightening process led to a decline in bank reserves, analysts say.
The Fed anticipated the upward pressure on short-term funding rates, setting up a plan on Sept. 13 for increased monitoring of money markets. Money market conditions remained calm that day, but the jump in rates on Sept. 16 was a sign that "markets were not effectively distributing liquidity across the system," Williams said.
On the morning of Sept. 17, it was clear "that this situation had persisted and had the potential to become more acute," he added, prompting the New York Fed to launch repo purchases.
The extended repo operations the New York Fed announced will be executed, in part, to guard against "the possibility of the development of strains in funding markets around the upcoming end of the quarter," he said.
"[The] announcement on open market operations to address potential quarter-end funding pressures on interest rates followed this same approach: quickly diagnose the problem, develop the right action plan, and execute that plan," he said.
The volatility has sparked analyst chatter that the Fed may start regrowing its balance sheet sooner than anticipated, with many analysts saying the Federal Open Market Committee may announce new purchases of assets at its Oct. 29-30 meeting.
Fed Chairman Jerome Powell has said the topic will be on the FOMC's October agenda. Williams said it is critical that the Fed "examine these recent market dynamics and their implications for the liquidity needs in relation to the overall amount of reserves" held at the Fed.
"The FOMC will assess the implications for the appropriate level of reserves and time to resume organic growth of the Federal Reserve's balance sheet consistent with the successful execution of the FOMC's ample reserves framework," he said.
