FX Street: The Repo Liquidity Crunch Reveals Market Stress. Will Gold Shine?
Article in FX Street
Last week, the Fed had to inject liquidity into the repo market for the first time since the Great Recession. Not once, but several times – and also commit to do more. Will such a crack in the proverbial dam let gold’s allure shine?
Scramble for Liquidity Pushes Rates Up
The focus last week was on the FOMC decision to cut interest rates. But a real drama was unfolding in the background. The Fed injected $278 billion into the securities repurchase, or “repo,” market over four days, to stabilize short-term interest rates and to calm the repo market scrambling for liquidity. More precisely, the U.S. central bank injected $53 billion in overnight repurchase agreement on Tuesday, followed by $75 billion re-open on Wednesday, then on Thursday and on Friday as well.
What happened? The liquidity dried up, which pushed the interest rates up. In particular, the effective federal funds rate jumped to 2.3 percent. It should have been in the target range of 2.00-2.25 percent before the Wednesday’s cut however. The Fed thus had to step in and inject some reserves to regain control over its main policy rate.
If you don’t feel impressed, please note that the U.S. overnight repo rate shot up from slightly above 2 percent to as high as 10 percent on Tuesday, while the Secured Overnight Financing Rate, the Fed’s measure of the cost of overnight borrowing collateralized by Treasuries, soared from 2.20 percent to 5.25 percent last week.
Implications for Gold
What does it all mean for the gold market? Well, in the short-term, not much. The panic has been contained, while the interest rates came back to their more normal levels. But there are important long-term implications. First, the turmoil could strengthen the dovish camp within the FOMC and prompt the U.S. central bank to restart the growth in its balance sheet, perhaps through quantitative easing. More dovish Fed should be supportive for the gold prices.
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