Fed needs further rate cuts to address US funding squeeze: Credit Suisse

The Federal Reserve needs to cut rates further to address a looming funding squeeze in US money markets being fuelled by foreign central bank demand for its reverse repurchase agreements, according to Credit Suisse Group. Usage of the foreign repo pool — where central banks invest cash with the New York Fed at rates comparable to money-market repo rates — is close to $100 billion so far this year, driven by haven flows, strategist Zoltan Pozsar wrote in a research note on Wednesday. It could hit $200 billion by year-end, exacerbating a glut in collateral caused by $800 billion in Treasury supply and driving up short-term funding costs. Pressure caused by this “supermassive black hole” would seep into the foreign exchange forward, cross-currency basis and Libor-OIS markets, according to the note.

“Because inflows into the facility sterilise reserves and add collateral to the financial system, they worsen the collateral surplus,” Pozsar wrote. 

“When banks are at their intraday liquidity limits it means that every penny that flows into the facility makes it harder for banks to fund dealers.”

Rate Shopping

Thanks to the trade war and inverted US yield curve, central banks attempting to weaken their currencies are making use of the RRP pool rather than buying Treasuries as they did in the past, Pozsar said. “Central banks are rate shopping and an uncapped foreign RRP facility is what enables that.”

A series of rate cuts to steepen the US yield curve and incentivize them to switch back to currency-hedged Treasuries would help solve the problem, rather than a technical fix, such as a standing repo facility or asset purchases that could lead to Treasury monetization, according to Pozsar.