Some big banks are cutting it close on a key regulatory measure, which could limit their ability to lend if year-end markets get rocky
Don’t rule out another bumpy New Year’s Eve in the funding markets. The lack of cash circulating in short-term money markets has pushed up the effective fed funds rate, the actual level at which banks lend to each other overnight. As a result, Hills says the CME’s tracker of rate decision probabilities may be reflecting the odds for the effective fed funds rate to remain elevated due to this week’s funding squeeze, rather than expectations for the fed funds target range going forward. The effective fed funds rate, the actual level at which banks lend overnight, jumped above the interest rate on reserves that bank keep in excess of their reserve requirements Usually, this is seen as a temporary state of affairs because banks have no incentive to borrow from another bank when it could simply withdraw funds on deposit at the Fed, but the persistence of the fed funds rate above the IOER has raised questions whether the central bank is losing its grip over its benchmark interest rate.
Market participants have pointed to the sharp jump in the repurchase rate, or repo rate. This key interest rate represents the amount that banks, dealers and hedge funds are charged for borrowing funds for a short period of time, in return for collateral such as Treasurys. Investors tend to be nervous about a climb in repo rates as they’re usually associated with banking crises and credit crunches. Repo rates spiked back in the 2008 financial crisis when banks were unwilling to lend to each other amid questions about their solvency.