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Financials

UPDATE 4-Overnight U.S. repo rate falls, after brief morning spike

(Updates price)

Dec 16 (Reuters) - The overnight repo rate fell on Monday, after a brief early rise, as the New York Federal Reserve’s efforts to inject liquidity into the market appeared to ensure there were enough loans to finance large corporate tax payments and Treasury debt settlements.

Still, some analysts and investors remain concerned that the cost of loans will rise during year end, when banks typically shrink their balance sheets.

The $2.2 trillion repurchase agreement (repo) market is a crucial source of funding and helps ensure that banks, companies and asset managers have the liquidity to meet their daily operational needs.

The market came under stress in September as demand for funds to settle Treasury purchases and pay corporate taxes overwhelmed loans available.

Investors are focused on the repo market this week as companies again face tax obligations while $78 billion in Treasury supply will need to be settled.

“When we had the real craziness and volatility in September it was exactly this time,” said Tom Simons, a money market economist at Jefferies in New York. However, “the Fed has done a lot to try to combat this.”

The New York Federal Reserve has increased the amount of liquidity it is providing to banks through its daily repo operations in a bid to avoid a repeat of September’s funding strains.

A 32-day repo operation on Monday was slightly oversubscribed, with the Fed accepting $50 billion from $54.25 billion in bids. The Fed also accepted all $36.40 billion in bids at an overnight operation.

The cost to obtain an overnight loan backed by Treasury collateral increased to 1.70%, from 1.62% on Friday, before dropping back to 1.52%. It remains within the Fed’s target range for the federal funds rate of 1.50% to 1.75%.

YEAR-END FOCUS

While the repo market appeared to be functioning smoothly on Monday, concerns remain that funding will dry up over year-end when banks typically pare their balance sheets.

The Fed’s repo operations are made only with major dealers, with the banks in turn passing liquidity on to their clients.

The banks are likely to reduce the availability of these loans over year end, however, as they seek to hit specific risk and capital ratios.

“Balance sheets are certainly going to dry up as we get closer to year end,” said Simons. “Dealers aren’t going to be taking on much extra, if any, to lend out to customers who might have to be paying up to fund themselves.”

Reporting by Karen Brettell in New York Editing by Matthew Lewis and Lisa Shumaker

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