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Federal Reserve plans cash injection to avoid Christmas cash crisis

By Lawrence Gash

Repo crisis rears its head once again, prompting fears of a run on cash over new year

The US Federal reserve is preparing to inject almost $500bn (£374bn, €449bn) into the financial system in order to see off a liquidity crisis. This further intervention comes as the repo market looks gears up for a repeat of September’s crisis.

The New York Federal Reserve has provided the market with $75bn (£56bn, €67bn) of cash and is reportedly planning to supply $225bn (£168bn, €202bn) and $190bn (£142bn, €171bn) in longer-term repo loans in order to stave off a run on cash over the new year. This further $490bn (£367bn, €440bn) comes on top of the $322bn (£241bn, €289bn) in liquidity that the Fed has injected into the market in the past three months.

The ongoing turbulence in the repurchase agreement (repo) market, where banks lend cash overnight to other institutions in exchange for collateral and repurchase the following morning, was triggered in September.

A sudden tightening of liquidity and a over-reliance on four banks as marginal lenders, saw the repo rate spike. A recent study by the central banks’ central bank, the Bank for International Settlements (BIS), attributed the cause of this spike to JP Morgan’s drain of liquidity via reserves at the Fed and the money markets but also claimed that hedge funds had exacerbated the trouble, almost pushing it into a full-blown financial crisis.

It is clear from published minutes of FOMC meetings that the Fed foresaw a Christmas cash crunch as early as October. This time of year regulators analyse the performance of major banks and decide on their ‘global systemically important bank’ (GSIB) scores. Thus across the festive period and into new year many such financial institutions attempt to avoid lending funds and to shrink their balance sheets.

In a speech on Wednesday December 11, Jay Powell, Fed chairman, stated that repo interventions have “gone well so far” and that he would continue to use them in order to calm funding markets when necessary. In order to ease further repo concerns the Fed has also been widening its balance sheet, purchasing $60bn (£45bn, €54bn) of Treasury bills with a maturity of a year or less a month to add cash to the market.

FURTHER READING Hedge funds exacerbated the recent repo crisis

FURTHER READING US and China reach phase one of trade deal

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