Asset manager Pimco said the US Federal Reserve’s creation of a permanent standing repo facility (SRF) will help develop more resilient funding markets, although it does have weaknesses.
On 28 July the US central bank announced the creation of of two standing repurchase agreement (repo) facilities – a domestic SRF and a repo facility for foreign and international monetary authorities (FIMA repo facility).
Under the domestic SRF, the Federal Reserve will conduct daily overnight repo operations against Treasury securities, agency debt securities, and agency mortgage-backed securities, with a maximum operation size of $500bn. The minimum bid rate for repos under the facility will be set initially at 25 basis points, somewhat above the general level of overnight interest rates. Counterparties for this facility will include primary dealers and will be expanded over time to include additional depository institutions.
Jerome M. Schneider, Head of Short-Term Portfolio Management and Jerry Woytash, Portfolio Manager, Short-Term Desk at Pimco said in a blog that given current easy financial conditions, the fund manager’s short-term desk does not expect any demand for this facility in the near term.
They added: “However, we believe the permanent SRF represents a consequential and preventative step toward developing more resilient funding markets. It has the potential to change the psychology of fear felt by market participants and banks during periods of stress.”
U.S. Treasuries are usually abundantly liquid with market depth and narrow bid-ask prices. However, when markets are stressed, such as in September 2019 and March 2020, dealers cannot make efficient markets and funding costs rise for U.S. taxpayers.
Pimco believes the SRF is a good first step but the main weakness of the facility is that it still relies on primary dealers to transmit liquidity to the buy side, and dealers’ balance sheets are constrained. The fund manager said access to the Fed for a broader set of participants during the volatility in March 2020 would have mitigated the severity of the market issues.
The managers recommended that the SRF could be expanded to allow the Fed to participate in sponsored repo so that the transmission mechanism for market liquidity would involve a wider spectrum of investors and end users during times of tighter financial conditions.
Pimco said: “Given the Fed’s renewed vigilance about market functioning, we would hope that this shortcoming will be addressed before we experience another period of market stress.”
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