Summary: Market participants see a quiet quarter-close as ample Federal Reserve liquidity reduces the short-term spikes in funding costs that can accompany the end of a month or quarter. Recent trading showed no use of the Fed's standing repo operations and only marginal reverse repo flows, consistent with expectations of limited stress. The central bank has been adding cash as a technical measure to keep money-market functioning smooth while retaining tight control over its policy rate range.
Participants in money markets say the Federal Reserve's replenishment of system cash is setting the stage for a calm turn of the quarter, with little evidence of the pressure that can push short-term rates sharply higher. The presence of abundant central bank cash has compressed the usual volatility seen around calendar windows when firms rearrange funding and liquidity positions.
“I expect normal turn-of-the-quarter pressures but nothing disruptive,” said Lou Crandall, chief economist with research firm Wrightson ICAP, reflecting a broadly shared view that any month-end churn will be mild and short-lived.
On Monday, market activity showed no borrowing through the Fed's standing repo facility and only marginal activity depositing funds into the Fed's reverse repo operations, a pattern observers interpret as a signal that trading ahead of Tuesday was poised to be uneventful. Typically, month-end and quarter-end dates prompt some market participants to step back from lending, which can briefly push money-market rates higher and drive counterparties either to park cash at the Fed's reverse repo facility or to tap the Fed's repo provision.
Those episodic pressures are most acute at quarter-end when institutions often perform balance-sheet housekeeping. Historically, such stress tends to dissipate quickly. This quarter end, as at year-end and at the close of March, the Fed is actively adding liquidity as a technical exercise to manage money-market conditions, preserve control of its policy rate range, and permit routine market volatility without disruption.
Reserve management purchases and the outlook
Late last year the Fed initiated Treasury bill purchases at a pace of $40 billion per month to ensure sufficient market liquidity ahead of the mid-April tax deadline. That program has since been scaled back to $10 billion per month amid debate over the appropriate scope of technical purchases and the broader size of the central bank's balance sheet.
Crandall said he is operating on the assumption that another $10 billion of reserve management purchases (RMPs) could occur in the July-August cycle, while acknowledging a range of potential outcomes: “At this point, I’m still assuming another $10 billion of RMPs in the July-August cycle, but wouldn’t be surprised by anything from zero to, say, $15 billion.”
BMO Capital Markets strategists, in a note on Monday, expressed the view that the Fed will maintain $10 billion per month in Treasury bill buying into late summer. The strategists pointed to current money-market rates as indicative of “relatively modest quarter-end pressures in the funding market.”
They also warned that if the softer tone in funding markets endures into the start of the third quarter, “there is a risk that the Fed reduces or temporarily halts reserve management purchases.”
Balance sheet debate and constraints
The Treasury bill buying program - referred to by the Fed as reserve management purchases - sits against a larger policy argument about the appropriate size of the Fed's balance sheet. The newly installed Chairman Kevin Warsh has expressed skepticism about the still-large balance sheet and has indicated he favors bringing it down. He said at the Federal Open Market Committee meeting earlier this month that he would be appointing a task force to study the matter.
Many economists and some central bankers have suggested Fed holdings could be reduced by altering rules so banks hold less highly liquid cash, though such a change would likely raise financial stability concerns. Estimates cited by market participants suggest that adjustments to liquidity rules could lower the Fed's holdings by as much as $1 trillion from the present $6.7 trillion level. Analysts, however, do not anticipate rapid action; any move to permit banks to hold less cash would need to be carefully designed to preserve the Fed's primary objective of maintaining control over its interest rate target.
Implications for markets
For now, the combined effect of the Fed's technical liquidity operations and subdued repo and reverse repo flows points to a low likelihood of a quarter-end spike in money-market volatility. That outcome would limit the need for large-scale use of central bank liquidity facilities and reduce pressure on short-term interest-rate benchmarks during the turn of the quarter.
Market participants remain attentive to the size and trajectory of reserve management purchases, and to any policy steps from the Fed's leadership task force on balance sheet sizing. Those developments would influence the pace at which the Fed withdraws technical support for money markets or modifies liquidity rules affecting banks.