Divided Fed Cuts Rates as Cash Shortages Roil Overnight Lending Markets

It’s been a busy week for the Fed.  Overnight Markets:  Monday and Tuesday saw the overnight borrowing rates spike to 10%, up from a normal rate of 2%.  Note that the highly watched rate set by the Fed is the Fed Funds target rate which is enforced via open market operations and other Fed tools but it is not set in stone.  Overnight lending amongst financial institutions is a critical factor in the financial markets.  Banks and other institutions use it to raise cash for daily operations and the loans are secured by Treasuries.  This week’s cash crunch was caused by a confluence of events including: corporate tax payments due Sept 15, large issuance of treasuries last week ($78 billion issued with only $24 billion matured, draining $50 billion of cash from the system), post crisis regulations mandating larger cash reserves held at institutions, etc.  The recent debt ceiling deal and US budget deficit is increasing the supply of treasuries substantially.  High overnight borrowing costs well in excess of the target rate are dangerous as it implies that the Fed doesn’t have control of the rates it is setting.  To its credit, the Fed acted swiftly yesterday and today, injecting over $100 billion into the financial system and overnight rates have calmed down.  Today’s Announcement:  Today’s 0.25% cut was expected and Fed Chair Powell’s press conference was closely watched for signs of future cuts.  Note that the futures market indicates a 42% chance of a cut in October.  The move was by no means unanimous (7-3).  Two voters wanted no cut with the extremely dovish member Bulliard alone advocating for a 0.50% cut.  Powell indicated that future actions are data dependent and stressed that the economy is strong with the exception of trade uncertainty.  It seems some Fed members believe we are at the “Goldilocks” neutral rate now. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners