Groucho Marx quipped that he wouldn’t want to belong to any club that would accept him as a member. On Wall Street, bank bosses have often declined to borrow money from a facility that would be happy to lend to them.
And with a plethora of risks bubbling up in stock, bond and cryptocurrency markets, and the level of overall bank reserves hovering near the lowest in four years, the Federal Reserve wants to see that change.
The central bank’s Standing Repo Facility (SFR) is a four-year-old tool in the Fed’s shed designed to allow banks access to enough cheap, available cash so that the broader financial system doesn’t run dry when lenders grow cautious.
Banks haven’t always been keen on using it, however, as if seeking access might suggest they are under financial stress. Last month U.S. lenders borrowed $110 billion from the SFR, the most since its 2021 introduction, but that tally still pales in comparison to the $3 trillion in repo transactions U.S. dealers make each day.
“Although the SRF has seen more frequent usage of late, a notable amount of repo transactions still have taken place in the market at rates above the SRF minimum bid rate,” said Roberto Perli, who runs the System Open Market Account for the New York Fed, earlier this month.
It has become enough of a concern that his boss, New York Fed President John Williams, met with several Wall Street banks at a Treasury market event in New York last week to try to shed that stigma as money market and repo borrowing rates ticked higher.
“Based on recent sustained repo market pressures and other growing signs of reserves moving from abundant to ample, I expect that it will not be long before we reach ample reserves,” Williams told the event.
The difference between abundant and ample is a key factor in the market’s ability to absorb shocks; bank reserves play a key role in both buffering their own balance sheets from unwanted risks but also keeping the broader financial system awash with liquidity.
That is proving more challenging at the moment, given that the Fed’s sale of bonds from its balance sheet, also known as quantitative tightening, has left overall bank reserves at around $2.85 trillion, the lowest in four years.
U.S. commercial banks may also be hoarding liquidity, and not lending in out in the repo market, to avoid recognizing around $400 billion in unrealized securities losses, according to Bank of America data.
Bank liquidity isn’t a critical concern at the moment; the tally is still more than double the $1.4 trillion level that stoked a repo market meltdown in the autumn of 2019. But with a series of risks building in other markets, such as fiscal risks in Japan and the United Kingdom, the potential for disruption remains acute. Crypto markets aren’t performing terribly well, either, and private credit markets in the U.S. are also a growing concern.
However, while overall risks are on the rise, and bank reserves are thin, investors likely don’t need to worry about the kind of near-term funding crisis, stoked by the failure of Silicon Valley Bank, that upended markets in the spring of 2023.
That’s largely because the Fed’s decision to end its quantitative tightening in December, a move which could ultimately lead to the re-expansion of its $6.6 trillion balance sheet, is set to provide relief.
Over time, Lawrence Gillum, chief fixed income strategist at LPL Financial, thinks that will “reintroduce liquidity into the system in ways that support risk assets.”
“With the conclusion of QT in sight—without a repeat of 2019’s spike in repo rates—an immediate risk to funding markets has been taken off the table,” he said.
It’s also being done quietly. And that’s exactly how Wall Street wants it.
Write to Martin Baccardax at martin.baccardax@barrons.com
