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The End of LIBOR: Further Market Liquidity Issues in Light of Market Turmoil

Last week, most observers focused on the more than 11% drop in the stock market due to public health and related supply concerns. In response, the Federal Reserve made an aggressive 50 basis point interest rate cut on March 4, 2020.

[1]

Stock Market Turmoil

This was the first time that the Federal Open Market Committee (FOMC) made such a cut outside of its regularly scheduled meetings since October 2008 during the height of the recent financial crisis, and the largest rate cut since its 75 basis point cuts in 2008. Additional pressures (e.g., oil price war) have added to turmoil this morning — yesterday, trading was halted for 15 minutes as the Dow at one point dropped nearly 2000 points.

Substantial Liquidity Infusions, and Mismatched Demand and Rates

This morning, the New York Federal Reserve (New York Fed) accepted $123.6 billion in submitted overnight repos, and $45 billion in term repos (out of $93 billion submitted). Under an FOMC directive to maintain the Federal Funds rate in a target range of 1 to 1.25 percentAnchor[2], the New York Fed released a statement dated March 9, 2020, that it will increase the amount offered for daily overnight repo operations on March 10 through March 12 from $100 billion to $150 billion, and, for two-week term repo operations, from at least $20 billion to at least $45 billion, all to deal with the coronavirus. [3] This was the first Statement and Operating Policy regarding repos since December 16, 2019.

Mismatched Demand

Even the balance of New York Fed infusions of $179.6 billion last week[4] were not the highest they have ever been — “$255.62 billion of New York Fed funds was outstanding on January 1, 2020.”[5] As one observer states: “I think the Fed hit the panic button…provided a huge record $100 billion into the overnight market and, for the first time, was still not able to fill the demand…Something is seriously wrong.”[6] For now, “People are interested in securing funding as it appears things are going to get worse before they get better.”[7]

And today and last week was not the first time New York Fed liquidity infusions had a substantial mismatch between liquidity requested by banks and the amount of liquidity supplied by the New York Fed. As mentioned in a recent Client Alert: “[d]uring the week of February 10th . . . term repos in an aggregate amount of $112.7 billion were submitted to, but only $60 billion were accepted by, the New York Fed.”[8]

Mismatched Rates

Serious health concerns aside, problems with market liquidity have plagued the repo market since the cash crunch of September 17, 2019, that saw the Secured Overnight Financing Rate (SOFR) spike from 2.2% to 5.25%. Last week, the “rate on overnight repo also rose temporarily to 1.80% before coming down to 1.70% [but only] after the Fed announced the rate cut”.[9] It should be further noted that there was a significant spread between the Fed Funds rate, an unsecured rate, and 1-month Treasury yields of approximately 30 basis points as of March 6th. Such spread appears to be widening even further.

Future

An updated Statement regarding Repurchase Operations is promised by the New York Fed this Thursday, March 12, 2020, at 3:00 p.m.,[10] to discuss its plans for monthly repo operations from March 12 to April 12, 2020.

 

[1] https://www.nasdaq.com/articles/the-stock-market-dropped-more-than-10-last-week.-heres-what-history-says-happens-next (last visited March 8, 2020).

[2] Implementation Note issued March 3, 2020, Board of Governors of the Federal Reserve System (last visited March 9, 2020). 

[3] Statement Regarding Repurchase Operations, March 9, 2020, New York Fed (last visited March 9, 2020).

[4] Michael S. Derby, Demand for Fed Repos Remains Robust; Friday Intervention just Shy of $90 Billion, Wall Street Journal, March 6, 2020 (last visited March 9, 2020).

[5] Michael S. Derby, Fed’s $100 Billion Repo Intervention Falls Short of Bank Demand, March 4, 2020 (last visited March 7, 2020).

[6] Gary Siegel, Fed Drops A Sudden Rate Cut, The Bond Buyer, dated March 4, 2020.

[7] Ian Lyngen, heard of US rates strategy for BMO Capital Markets in New York, quoted in Reuters, Update 1- Coronavirus fears could boost demand for Fed repo support (last visited March 6, 2020).

[8] Les Jacobowitz, The End of LIBOR: SOFR and Related Updates, dated February 19, 2020 (last visited March 9, 2020).

[9] Id. Note 7.

[10] Id. Note 3.

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