When the repurchase agreement (repo) market had its September crisis, players focused on the yearend, when liquidity is most stressed. But by adding about $400 billion to its balance sheet since then, and vowing to continue buying Treasury bills into the second quarter, the Fed averted a blowup.
The Fed doesn’t view its actions as quantitative easing, perhaps because it is injecting liquidity to ensure an appropriate level of cash reserves for banks, rather than buying distressed assets.
“The orderly yearend operation of the repo market — when cash demands were heightened due to capital surcharges, regulatory requirements, and asset manager ‘window dressing’ — suggests that Fed liquidity operations were a success,” said Brian Rehling, Wells Fargo Investment Institute co-head of global fixed income strategy.
The next logical move, he said, is for the Fed “to formulate a more permanent plan to address repo liquidity issues.” That could be “some type of permanent repo facility that can be used as needed, along with a permanent increase in the Fed’s balance sheet.”
Although it has committed to buying Treasury bills at least into next quarter, “These additional purchases could end once the Fed’s leaders feel that it has reached an equilibrium in funding markets,” Rehling said. “The increase in the Fed’s balance sheet (some of which we believe could be permanent) has effectively increased liquidity — likely helping to fuel recent financial-asset price appreciation. We would expect the Fed to be cautious in any future attempts to remove liquidity from financial markets.”
Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management, noted, "The last repo operation at yearend was not fully subscribed, which shows that all yearend funding needs were met. As expected, there was not a spike in the repo rate at the end of 2019.”
More work remains. “This doesn’t mean the Fed’s task to manage repo rates is finished,” Ren said. “Ample excessive reserve has to be maintained on the Fed’s balance sheet and regular repo operations are still needed, especially around quarter and yearend."
Trade deficit
Separately, the trade deficit dropped to $43.1 billion in November, the lowest it’s been since October 2016, as imports fell, likely the result of the trade war with China. Exports rose.
The Commerce Department revised the October deficit to $46.9 billion from the initially reported $27.2 billion. “Year-to-date, the goods and services deficit decreased $3.9 billion, or 0.7%, from the same period in 2018,” Commerce said. If the trend continues in December, this would be the first time since 2013 the deficit declined for the calendar year. Economists polled by IFR Markets expected a $43.9 billion shortage.
Factory orders
Factory orders declined 0.7% in November, Commerce reported Tuesday, while the figure for October was downwardly revised to a 0.2% gain from the 0.3% advance first reported last month.
Economists predicted a 0.8% drop in orders.
Year-over-year orders fell 0.7%.
Excluding transportation, orders rose 0.3% in November, the same pace of growth as in October. Durable goods fell 2.1% after a 0.2% rise in October, while nondurables gained 0.6% after a 0.3% climb.
ISM non-manufacturing index
The ISM non-manufacturing index rose to 55.0 in December, its highest level since August, from 53.9 in November.
Economists expected a 54.4 read.
The business activity/production index also gained, to 57.2 from 51.6, the Institute for Supply Management said Tuesday.
