As differing factions battled over lowering the interest rate, something curious happened. Despite the Fed’s best efforts, the target interest rate spiked. It exceeded both the current maximum target of 2% and the previous 2.25%. At 2.3%, the Fed had officially lost control of the interest rate – albeit briefly. Given the overwhelming public focus on the Federal Reserve, this is a worrying situation. Control over the interest rate is paramount for investor confidence within the United States.
The immediate repercussions of this falter will depend on the market. As a temporary emergency, it’s simply worrying. However, if the conditions continue, it could turn into a serious underlying issue. The Fed’s response did bring the interest rate back under control. Several repo actions over the past few days wrangled interest rates back to their intended target. If interest rate volatility remains outside of their parameters, the Fed may find themselves pressured into less than optimal actions.
Cause and Effect
The unexpected rise in interest rates appears to be caused by a minor liquidity shortage. Banks and companies needing cash can use the overnight funding market to briefly supply these needs. A larger than anticipated demand in this sector spiked the interest rate. On its own, this hiccup is not overly worrisome. Coupled with the current environment of economic uncertainty, it could signal further problems to come.
The Federal Reserve responded to the sudden increased demand by injecting billions of dollars into the market. These repurchasing agreements, or ‘repos’, lower the interest rate by vastly increasing the supply. During the week of September 20, 2019, the Federal Reserve conducted four straight days of these operations – ensuring that their new target interest rates are maintained.
On Tuesday, September 17, 2019, the N.Y Fed injected $53.2 billion, followed by $75 billion daily on Wednesday, Thursday, and Friday. However, the Federal Reserve appears to be extending its repo operations into October.
On Friday, September 20, 2019, the New York Federal Reserve Bank announced that it will inject up to $75 billion per day through October 10, 2019. In addition to the daily injection, the N.Y. Fed will offer three 14-day repo operations of at least $30 billion each. After the October 10th target, the N.Y. Fed says will continue to “conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined,” according to a statement released by the Fed.
Intense Focus on the Federal Reserve and Repo Rates
This market action could not come at a worse time. The current U.S. Administration have railed against the Federal Reserve for maintaining their current interest rate targets, as negative interest rates continue to be a prevailing global trend. Increasingly pressure forced the Fed to reduce their rate by 25 basis points to 2-2.25%. Then, as the current liquidity crisis began, they lowered the target to 1.75-2%. President Trump considers this insufficient and continues to push for negative interest rates.
Negative interest rates come with some potential side effects. In the face of a potential recession, such a decision would leave the Fed little wiggle room to boost the economy. Their decision will hinge on current market conditions – but increasingly, public pressure seems to be driving them towards a zero or negative rate.
Article By: Adam Stone