Fed should delve into causes of cash shortage
The Federal Reserve will have to delve into the causes of the cash shortage that hit financial markets last week and prompted the central bank to step in, New York Fed President John Williams said Monday.
When the cash crunch worsened, clogging the plumbing for the US financial system, the Fed “acted quickly” and this “had the desired effect of reducing strains in markets,” Williams said in prepared remarks.
But he acknowledged that the reaction was worse than expected.
The episode highlights “the vital role that the Federal Reserve plays in supplying liquidity to the system when markets are under stress. We were prepared for such an event, acted quickly and appropriately, and our actions were successful.”
But it remains important to “examine these recent market dynamics” that led to the situations, Williams said. “We will continue to monitor and analyse developments closely.”
The comments came as the Fed continued to offer $75 billion in short-term cash loans to banks to ensure they have enough reserves to meet the minimum requirement.
However, in a sign the liquidity shortage may be easing, on Monday, the fifth day of emergency cash injections, the New York Fed received requests for only $65 billion.
Williams said the Fed was expecting some issues at the end of the quarter as an array of conditions converged to dry up liquidity in the banking system -- including quarterly corporate tax payments and a surge in government debt sold to investors, which drained cash out of banks.
As a result, short-term interest rates were rising sharply, outside of the Fed’s desired range.
He said “the size of the reaction in repo rates, the spillover to unsecured markets such as federal funds, and the emergence of strains in market functioning were outside of recent experience.”
In last week became clear that “markets were not effectively distributing liquidity across the system” and the situation “had the potential to become more acute,” Williams said.
After four days of so-called repo operations, the New York Fed announced Friday it would conduct the cash injections daily through October 10.
Banks borrow regularly in markets for very short periods, usually overnight, to make sure their daily cash reserves do not fall below the required level. But interest rates increase with demand. The New York Fed adds or removes liquidity to keep interest rates in line with the desired target range.
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