Rate Cuts, Repo Ops, and Recessions: How the Fed is Quietly Cleaning up Donald Trump’s Messes

Jordan Saddoris – In today’s alternate reality where a single tweet swings financial markets by the billions, the Federal Reserve is quietly making policy decisions that protect against increasing market volatility and recessionary fears. Slowing global growth, never-ending trade negotiations with China, and rising political uncertainty have led to serious recessionary fears in US markets. In fact, an August poll showed that 74% of the 200+ economists polled now believe the US will enter recession before the end of 2021. Despite these concerns and political pressures, the Fed’s policies have enabled markets to reach record highs.

Broadly speaking, under the Federal Reserve Act of 1913, the Federal Reserve (commonly referred to simply as the ‘Fed’) is responsible for setting monetary policy, promoting stability in the financial system, and regulating financial institutions activities. Encouraging employment, stabilizing prices, and supporting the health of the U.S. economy are just a few of the Fed’s operational objectives. Open market operations are the Fed’s most influential method of conducting monetary policy via the federal funds rate. In response to the recent market conditions, the Fed’s open market activities have been focused around two primary operations: (1) lowering the federal funds rate; and (2) participating within the repo market.

Fed Funds Rate Cuts

A vital tool in the Fed’s monetary policy arsenal, the federal funds rate,is the target range for interest rates at which banks lend their reserves to one another. By decreasing the federal funds rate, the Fed is able to stimulate the US economy in times of foreseen weakness. For example, two weeks before an all-time high for the Dow Jones Industrial Average in 2007, the Fed cut rates from 5.25% to 4.75% citing volatility and a correction in the housing market. Just months later the US economy was in the midst of the worst financial crisis since the Great Depression due to the factors cited by the Fed.

Fast forward to 2019, where the Dow again hit all-time high in July only to be followed two weeks later by the Fed lowering the federal funds rate for the first time since the financial crisis. Unlike in 2007, concerns over the housing market were not the driving factor of the cuts. Instead, the Fed reacted to the increased uncertainty around a trade deal with China and the inflationary pressures that have resulted from it. On Wall Street, the rate cut was widely viewed as insurance against the 140-character market shocks of the trade war. Nevertheless, the same Twitter-diplomacy fueling recessionary fears was used to express the Trump Administration’s displeasure with the “boneheads” at the Fed for not granting further stimulus. Yet, cutting rates too early would result in a lack of available monetary stimulus when needed most, as evidenced by the seven rate cuts essential to bring the nation out of recession in 2008.

Repo Operations

Unknown to main-street investors, Wall Street’s repo market is a vital part of the US financial system and is actually what funds most money-market savings accounts. Short-term repurchase agreements, known as repo loans, are essentially two-step transactions. On the front end, a party agrees to provide cash in exchange for securities as collateral; while on the back end, the counter-party agrees to repurchase the securities at a later date (typically the following day) at a slightly higher price. That difference in price determines what is called the “repo rate”.

Back in mid-September, repo rates spiked more than 300% from a normal 2.29% to 10% the very next day. While opinions on causation vary from simply end of the fiscal quarter taxes to a hidden looming bankruptcy, the catalyst for the upsurge in rates is still unknown. Regardless of cause, the rate spike sent shockwaves that spooked Wall Street traders. Coming in to save the day, the Fed promptly stepped into the repo market with the goal of bringing rates back down within the target range for the federal-funds rate. In doing so, the Fed began offering billions in short-term cash to financial institutions for the first time since 2008. In the twelve trading days between Sept. 20thand Oct. 4ththe Fed accepted over 92% of requests, injecting $782.27 billion into the financial system. Such swift action by the Fed promptly brought repo rates back within the federal funds target range and prevented more widespread panic amongst investors.

The Fed may be fighting an uphill battle, but its efforts to protect financial markets from the Trump Administration have been rewarded. As Americans continue to fear an upcoming recession, they can take solace in the fact that the Fed is in the background doing its best to keep this nation’s leader from creating one.

Leave a Reply

Your email address will not be published.