Financial firms show greater demand for Fed's repo offerings

Jan 14 (Reuters) - Financial firms showed greater demand for short-term cash loans from the U.S. Federal Reserve on Tuesday, after demand dropped off near the end of last year.

The U.S. central bank’s offering for a two-week loan in the repurchase agreement, or repo, market was oversubscribed Tuesday morning for the second time since last week. Firms requested $43 billion in loans on Tuesday, greater than the $35 billion maximum offered by the Fed. Demand for the two-week repo offering on Jan. 7 also exceeded supply, when $41 billion in bids were submitted.

The year-end liquidity crunch feared by Fed officials, Wall Street firms and analysts never materialized, and firms took up only a small portion of the repo offerings made available by the central bank. But financial firms now want to know what the Fed’s exit strategy will be after it became a dominant player in the repo market over a four-month period.

The Fed has been intervening in the overnight lending markets for cash since mid-September, when a liquidity shortage pushed short-term borrowing costs up to 10%, or more than four times the top of the federal funds target range at the time. The central bank also moved in mid-October to expand its balance sheet and permanently grow the level of reserves by purchasing $60 billion a month in U.S. Treasury bills.

The New York Fed will release the schedule for upcoming repo operations at 3 p.m. EST (2000 GMT) on Tuesday. Investors will be looking to see if the Fed reduces the size of its offerings or adjusts the rate charged. The bank will also issue an update on its monthly Treasury bill purchases.

Some strategists wonder if the increased demand for repo offerings signals a need for liquidity or if firms are simply taking advantage of low-cost financing from the Fed.

“They’re offering cheaper liquidity than the market so why would dealers not go to the Fed for that funding?” said Blake Gwinn, head of front-end rates strategies for NatWest Markets.

One way to wean firms away from the Fed’s offerings could be to raise the rate charged slightly, Gwinn said. That could give dealers the incentive to turn to the private market for funding, he said, adding that they could return to the Fed if there was a shortage.

“The Fed should really start communicating and letting people know this is not a permanent state of affairs,” Gwinn said. (Reporting by Jonnelle Marte Editing by Paul Simao)