July 14, 2019 / 6:52 PM / 3 months ago

U.S. Fed seen launching repo facility in early 2020: Deutsche Bank

(Reuters) - The Federal Reserve may launch a policy tool to lend to banks using Treasuries and other securities as collateral in early 2020, with possible testing to begin later this year, a Deutsche Bank strategist said.

FILE PHOTO: Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis/File Photo

Such a standing fixed-rate repurchase agreement, or repo, facility would serve as a backstop against sharp spikes in interest rates in money markets, which are occurring with growing frequency at month- and quarter-end.

“We reaffirm our expectations that the Fed could test this facility later this year and launch it for full-scale operations in early 2020,” Deutsche Bank strategist Steven Zeng wrote in a research note published late on Friday.

Fed policymakers debated the merit of a repo facility in June. There is no consensus yet on the design of the facility.

Other Wall Street analysts questioned whether a repo facility would happen any time soon when the central bank may end its balance sheet normalization and restart its purchases of Treasuries sooner than it has planned.

“Our base case remains for this facility to be implemented eventually, but we think it can take longer than we previously expected – around Q3 2020 – given diverse opinions on the parameters from the participants,” Citi Research rates strategist Steve Kang wrote in a research note.

Still, the Fed and financial markets stand to benefit from a repo facility, Deutsche Bank’s Zeng said.

For the Fed, such a program could shrink more of its balance sheet, currently at $3.86 trillion, and may discourage big banks from hoarding reserves, resulting in more even distribution of reserves to smaller banks, he said.

For traders and investors, a repo facility could support Treasuries trading volumes and liquidity by offering more flexibility to banks to move between holding reserves and holding securities, he said.

Big U.S. banks have clung to a large share of excess reserves, rather than lending them, partly to meet liquidity requirements enacted in response to the global financial crisis a decade ago.

More bank demand for Treasuries could help lower bond dealer holdings of them. Dealers’ need for financing to hold their Treasuries inventory has contributed to the intermittent spikes in repo rates on the open market, he said.

The Fed may initially set the facility’s fixed rate at 35 basis points above the interest the Fed pays on bank reserves. The spread could be adjusted up or down, Zeng said.

He reckoned the Fed would allow banks and primary dealers, or the top 24 Wall Street bond firms that do business directly with the Fed, to access the repo facility.

Reporting by Richard Leong in New York; Editing by Nick Zieminski and Peter Cooney

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