The Fed is widely expected to cut rates at its upcoming October 29 Federal Open Markets Committee (FOMC) meeting, with few surprises anticipated in its statement or forward guidance given the absence of updated economic projections.
A key question is whether the Fed will move to end quantitative tightening (QT), as recent upward pressure on the overnight repo rate has raised concerns that the Fed may be facing a liquidity problem. A similar situation occurred on September 17, 2019, when the overnight repo rate surged and the Secured Overnight Financing Rate (SOFR) spiked from 2.3 per cent to a high of 10 per cent intraday. In response, the Fed injected $75 billion into the repo market to stabilize rates.
In the paper Anatomy of the Repo Rate Spikes in September 2019, the authors explain that the surge was largely driven by a confluence of fundamental factors—large Treasury issuances, corporate tax deadlines, and an overall lower level of reserves—that individually would not have been nearly as disruptive. They suggest that segmentation within the repo market, combined with a lack of price transparency across market segments, may have contributed to the rate spike. While some market participants began to recognize that cash supplies were scarce on September 16, others either did not notice or were unable to lend in response to the tightening conditions.
More recently, the overnight repo market has come under pressure, prompting some analysts to warn of a possible funding crisis that could hasten an end to QT. The Fed has tools to manage intraday tightness, including the Standing Repo Facility (SRF), which allows banks to step into the repo market when rates rise sufficiently above the Fed’s policy rate for repos—currently 4.25 per cent following the September rate cut. Banks borrow at the SRF’s rate and lend those amounts at higher rates in the repo market, profiting on the spread. For example, when the Secured Overnight Funding Rate (SOFR)—which tracks a $3-trillion-a-day segment of the repo market—reached roughly 4.4 per cent, banks borrowed at 4.25 per cent through the SRF and lent overnight in the repo market at the higher rate, helping to ease upward pressure on SOFR.
It is not surprising that the repo market rate is fluctuating, given that the Fed’s QT has withdrawn $2.4 billion of excess liquidity from the market. Repos conducted through the SRF are overnight transactions that mature the next business day when banks repay the amount borrowed and reclaim their collateral. Unlike quantitative easing (QE) bonds, these repos don’t stay on the Fed’s balance sheet for years or decades, which is why the SRF balance returns to zero on days it is unused.
The SRF exists to relieve upward pressure on repo market rates. The September 2019 spike prompted the Fed to intervene directly in the repo market, effectively reversing a significant portion of the QT implemented over the prior two years. Since then, the Fed has learned an important lesson.
In July 2021, as part of its preparation for withdrawing liquidity through QT, the Fed re-established the SRF, which had been shut down in 2009 and was not in place during the September 2019 spike. The facility has since been improved, including the addition of a morning auction, so that it now operates both morning and afternoon auctions to better align with daily liquidity flows.
Liquidity conditions have tightened but remain within normal limits. Federal Reserve Chair Jerome Powell hinted that the Fed is likely to end QT in the coming months while continuing to monitor key indicators. Based on his remarks, it seems unlikely that the Fed will end QT in October; December or early 2026 appears more likely.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Canadians are feeling the squeeze of high housing costs, and the debate over affordability is intensifying. Recently, Federal Housing Minister Gregor Robertson suggested that average house prices need to fall to restore affordability. But what does “affordable” really mean, and how can prices realistically adjust? Our latest Housing Affordability Watch breaks it down.
Read it here: Do House Prices Need to Fall?
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