The reluctance of the top four U.S. banks to lend cash mixed with a rise in demand from hedge funds for secured funding could explain a current hike in the U.S. money market rates, the Bank for International Settlements stated.
Cash available to banks for short-interval funding all however dried up in late September, and rates of interest deep in the plumbing of U.S. financial markets soared into double digits.
That forced the Fed to make an emergency injection of billions of dollars for the first time since the global financial crisis.
While the precise cause of the squeeze is still vague- with explanations ranging from large withdrawals for quarterly tax funds to a significant settlement of a trade in U.S. Treasuries – BIS analysts said the rising dependence on the biggest U.S. banks to keep the repo market functioning might have been a vital factor.
The big four banks, which BIS didn’t name in its report, have become net suppliers of funds to repo markets as they account for over half of all Treasuries held by banks in the U.S. at the Federal Reserve.
The repo market underpins much of the U.S. financial system, helping ensure banks have the liquidity to fulfill their daily operational requirements.
The system usually goes along with the interest rate charged on repo deals to hover close to the Fed’s benchmark overnight rate, which it cut Wednesday to 1.75% – 2.00% from 2.00% – 2.25%.
However, in late September, interest rates shot up to as high as 10% for some overnight loans, i.e., over four times the Fed’s policy rate, raising concerns in regards to the fragility of the U.S. greenback funding markets.