NEW YORK, Dec 10 (Reuters) - The Federal Reserve’s efforts to calm money markets could fall short at the end of the year, potentially leading to a spike in Treasury yields and forcing the central bank to resort to launch a round of quantitative easing, a Credit Suisse analyst warned this week.
Borrowing rates in the repo market spiked to 10% in mid-September, above the Fed’s target rate of 2.25%, after larger-than-expected Treasury settlements and corporate tax payments created a liquidity crunch.
Wall Street firms and traders are preparing for a possible repeat of that volatility in the middle and end of this month, when events similar to those that caused the rupture in September - including large Treasury settlements and a corporate tax deadline - are expected to reduce the amount of reserves in the banking system.
At the same time, some large banks may reduce their lending in the market for repurchase agreements, or repo, in a move to shrink their balance sheets and avoid higher capital requirements.
The Fed’s efforts to boost liquidity in money markets by purchasing Treasury bills and providing temporary operations in the repo market may not be enough to close the cash shortfall at year-end, Zoltan Pozsar, an analyst for Credit Suisse, wrote in a note published Monday.
“If we’re right about funding stresses, the Fed will be doing ‘QE4’ by year-end,” Pozsar wrote.
The Fed began purchasing $60 billion a month in Treasury bills in mid-October, a move meant to expand the balance sheet and increase the level of reserves in the banking system. Fed officials have characterized it as a “technical move” meant to shore up money markets, differentiating it from the bond purchases made during the crisis, which were meant to bring down long-term interest rates and boost the economy.
Pozsar argues the Fed could be pushed into a more traditional round of quantitative easing if money market funds are disrupted again.
Hedge funds could decide to sell their Treasury bonds if the overnight lending markets become too volatile, he said. That selloff could push the Fed to take more drastic measures, Pozsar wrote.
“Treasury yields can spike into year-end, and the Fed will have to shift from buying bills to buying what’s on sale – coupons,” he wrote.
However, some analysts say the Fed’s efforts to boost liquidity have succeeded in calming markets. Hedge funds and other firms that could be in need of cash may also be shoring up reserves ahead of Dec. 31, minimizing the risk of volatility.
Reporting by Jonnelle Marte; Editing by Lisa Shumaker
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