By Michael S. Derby 

The morning after the Federal Reserve fired its most available weapons to help the economy navigate the coronavirus threat, demand for its temporary liquidity again fell well short of what the central bank was willing to provide.

On Monday, the Fed offered eligible banks two repurchase agreement operations, or repos. In the one-day interventions, so-called primary dealers sought $129.6 billion in loans versus the $175 billion the Fed was willing to provide. The Fed's repo operation with a $500 billion cap that runs until April 13 garnered even more modest demand, with dealers taking $18.45 billion.

Later Monday morning, the Fed announced that it would offer a second repo operation with a $500 billion cap, even as its earlier foray saw limited interest. In announcing the action, the Fed said "this action is taken to ensure that the supply of reserves remains ample and to support the smooth functioning of short-term U.S. dollar funding markets."

Jon Hill, a strategist at BMO Capital Markets said money markets -- most notably in the repo sector where firms borrow and lend cash and Treasurys short-term -- have been "very volatile" on Monday. A key overnight repo rate has traded as high as 2.50% despite the Fed's interest on excess reserves rate standing at 0.10%, he said, adding "introducing a second [operation] later in the day could help some primary dealers clean up funding for positions."

Fed repo operations take in Treasurys, mortgages and agency securities from primary dealers in what are effectively collateralized loans from the central bank. The operations are aimed at controlling the federal-funds rate, the central bank's primary tool for achieving its inflation and job mandates. Repos are a very long running tool for the Fed, and dealers accessing the loans pay interest and face individual limits for what they can borrow.

The Fed's repo interventions on Monday followed a historic Sunday evening for the central bank. To protect the economy and financial system against coronavirus risks, the central bank slashed its overnight interest rate target to effectively zero, announced a major expansion of its bond buying efforts and tweaked bank oversight rules -- harkening back to its actions during the financial crisis.

Last week, the Fed increased its repo offerings three times in a bid to help improve troubled functioning in the bond market. While the Fed massively upsized the amount of money it was willing to loan markets, dealers didn't show up in force to take it. Part of that was because primary dealers aren't in position to fully exploit the Fed loans, but there are also other issues. The overall amount of Fed temporary liquidity on Monday ticked down to $317.9 billion from $344.6 billion on Friday.

In his conference call with reporters after the Fed acted on Sunday, Fed Chairman Jerome Powell said the relatively modest demand on its massively expanded repo operations spurred the Fed to expand its bond buying.

"What we learned was that we needed to go direct here rather than trying to intermediate through the dealers" and unstick bond markets by buying securities, Mr. Powell said. After starting with a more modest course of buying Friday -- the Fed switched from Treasurys only to broader buying -- "we saw that market function improved a little bit, but still it wasn't what we needed," which is why the buying was expanded on Sunday, he said.

The Fed is also trying to address broader liquidity concerns by encouraging commercial banks to use the so-called discount window emergency lending facility. This tool has suffered from heavy stigma for many years, and with the exception of the financial crisis, is almost never used. Firms fear that using it, even for legitimate reasons, will leak out and send a signs to other banks that they are in trouble.

To spur usage of the discount window the Fed lowered its rate by 1 1/2 percentage point to 0.25%. It said on Sunday it was encouraging "depository institutions to turn to the discount window to help meet demands for credit from households and businesses at this time." Whether the discount window is being used will be seen on Thursday, when the Fed next updates information on its balance sheet.

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

March 16, 2020 13:06 ET (17:06 GMT)

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