New York Fed’s tweak to key repo facility hampered by its design

The Federal Reserve Bank of New York’s plan to conduct additional liquidity operations through the end of the year will provide needed support at a time when funding markets tend to be volatile, though its current framework will limit the effectiveness of the measures.The Standing Repo Facility, or SRF, allows eligible banks and primary dealers to borrow funds overnight in exchange for Treasury and agency debt at a rate set by the Fed. The goal of a having a rate set by the Fed is to contain the overall repo market from pushing outside the central bank’s target range.The New York Fed last week said it plans to offer a second Standing Repo Facility operation on each business day from December 30 to January 3, ameliorating criticism in markets about the late-day timing of the existing offering. That means in addition to scheduled daily operations from 1:30 pm to 1:45 pm. ET, the bank will conduct a second operation from 8:15 am to 8:30 am on those days. Both tranches will settle together on the tri-party platform late in the day.While afternoon operations are considered useful for addressing one-off liquidity issues for individual banks, morning operations are perceived as a more effective tool for easing broader market strains, according to Wrightson ICAP."Market participants have identified the late-day timing of the existing operations as one of the factors inhibiting use of the facility, and adding an early round could be a significant enhancement over time,” Wrightson ICAP economist Lou Crandall wrote in a note to clients on Monday. "Running early and late sessions each day on a regular basis would broaden the scope of the programme.”The focus on the SRF comes at a critical moment given that funding markets have grown more volatile beyond the typical surges during month- and quarter-ends, when banks shore up their balance sheets for regulatory purposes by reigning in repo activity. Activity around next week’s end of year has taken on more significance since a spike in repo rates in September has stirred concern in markets that volatility on December 31 may go be even higher.While balances at the SRF on September 30 rose to the highest level since before the daily operations were made permanent more than three years ago, market rates surged, touching 5.90% at one point.New York Fed President John Williams said in a CNBC interview on Friday repo volatility could be similar to what the front end experienced at the end of last quarter. While policymakers aren’t particularly worried about year-end beyond typical pressures, it’s a chance to adjust the parameters at a time when it’s economically convenient for counterparties to use the facility.After the announcement, the rate on overnight general collateral repurchase agreements for the year-end turn — the December 31 to January 2 period — touched 4.85%, though retraced to the mid-4.90%s by the week’s end, according to JPMorgan Chase & Co.Yet for Wrightson’s Crandall and JPMorgan strategists Teresa Ho and Pankaj Vohra, it’s unclear how much officials will glean from this exercise as there’s a few issues that suggest changes to the SRF won’t be effective in supporting funding markets.For starters, the program operates in uncleared client-to-dealer tri-party transactions, one of three segments in the market. Because of this, cash is settled/received in the afternoon, which doesn’t help dealers funding clearing accounts before they’re penalized with daylight overdraft fees in the morning, Ho and Pankaj wrote in a note on Friday.In addition, the program is not centrally cleared so any activity will add to the balance sheet costs of dealers that are already facing constraints."In the current operational framework, though, the Fed is not actually moving the cash infusion up to the morning,” Wrightson’s Crandall wrote. "The delayed late-day settlement probably won’t do much to ease overnight market gridlock if a squeeze does materialize next week.”Still, even if the facility remains infrequently used during this trial run, these changes could open the door to other changes to the SRF that encourages more frequent use."Over the longer run, finding a way to get the cash into the system earlier in the day would be important,” Crandall said.