The Fed Switches on The Cash Taps

At a Glance

  • As corporations look to meet quarterly tax payments, Fed looks to inject money into the system for first time since 2008 crisis
  • Trading in SOFR futures breaks all-time records in response to rate volatility

Cash has drained from the financial system in recent days as corporations have withdrawn deposits from banks or money-market funds in order to meet their quarterly tax payments.

At the same time, the settlement of mid-month U.S. Treasury coupon auctions means there’s more collateral in the repo market. The increases in both demand for cash and supply of available securities have led to upward pressure in the repo overnight lending market.  On Monday, this pushed the Secured Overnight Financing Rate (SOFR) benchmark published by the Federal Reserve up to 2.43 percent, compared to 2.20 percent on Friday and a month-to-date average of 2.17 percent.

Such a liquidity-driven run up is commonly seen at quarter-ends, when corporate funding needs impact short-term borrowing, such as in December 2018 when the rate briefly jumped from 2.46 to 3.00. But given the off-cycle spike, the New York Fed announced on September 17 that it would initiate $75 billion in repo transactions, injecting cash into the financial system to boost liquidity.

Brother, can you spare $75 billion?

This is the first time since the financial crisis of 2008 that the Fed has looked to inject money into the system. Since the crisis and the recession that followed, the market has become accustomed to seeing the Fed remove cash from the system, rather than adding it via the Repo market.

The question many observers are asking is whether this is the start of a fresh round of quantitative easing by the Fed.

Meanwhile, the Federal Open Market Committee met on September 18, and decided to lower its target rate by .25 percent. Ahead of the meeting, CME Group’s Federal Funds futures markets implied a 70 percent probability of a 25-basis point cut in interest rates compared with a 30 percent probability of no change.

SOFR, so good

Trading in CME’s One-Month and Three-Month futures contracts, which track the benchmark Secured Overnight Financing Rate (SOFR), increased in response to the volatility.

Daily volume increased from a little over 30,000 lots September 10 to 84,000 lots September 16, and set a record of 152,000 on September 17.  At the same time, the contracts saw a combined rise in open interest from 265,000 to 312,000 lots, equivalent to approximately $1 trillion in notional value.

As short-term interest rates return to a period of greater volatility, interest rate futures are enabling market participants to hedge their exposure in highly liquid markets.  CME’s offering includes SOFR futures (and soon SOFR options), Fed Funds and Eurodollar contracts as well as cash treasuries and repo trading on the BrokerTec platform.

Whether or not a new round of quantitative easing ensues, trading in these markets will be an important barometer for market watchers in the months ahead.

is Global Head of Research at CME Group. He is based in London.

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