A Huge Crack Just Appeared in the Financial Markets Overnight
A large crack has appeared in the financial markets overnight in a segment of the market that the public rarely, if ever, notices. This crack, however, is crucial to the functioning of the global financial system.
Borrowing rates skyrocketed on Tuesday forcing the New York Federal Reserve to come to the rescue with a special operation aimed at easing stress in financial markets. According to CNN, this was the NY Fed’s first such rescue operation in a decade, the last occurring in late 2008. “It’s unprecedented, at least in the post-crisis era,” said Mark Cabana, rates strategist at Bank of America Merrill Lynch.
The first attempt by the NY Fed to ease some pressure on the markets was canceledbecause of “technical difficulties.” Just a few minutes later, the NY Fed successfully injected $53 billion into the system. The episode demonstrates evidence of emerging strains in financial markets and raises concern that the Federal Reserve could be losing its grip on short-term rates. “The funding markets are clearly stressed,” said Guy LeBas, managing director of fixed income strategy at Janney Capital Markets. “It’s going to require Fed action.”
What is strange, is that it isn’t really clear what caused the strain in the markets this time. It did happen overnight, but no one knows how long it will last either. “No one knows why this is happening,” Jim Bianco CEO of Bianco Research, said on Twitter. “If it persists more than another day or two, it will be a problem.”
The catalyst for the stress, according to Cabana, a BAML strategist, was the fact that U.S. companies withdrew vast sums of money from banks to make their quarterly extortion payments to the U.S. Treasury Department. That forced banks to draw down their reserves at the Fed. It could also be a problem with the massive surge in government spending, and a sharp rise in Treasury bonds being issued to cover the now $1 trillion deficit.
But this is just the beginning and the first huge crack in the financial markets.
The Fed may also need to lower the interest it pays on excess bank reserves or IOER. Bank of America Merrill Lynch predicted the Fed will cut this rate slightly on Wednesday. “That’s like a Band-Aid,” Cabana said.
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