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Potential signs of trouble are popping up again in the form of tighter conditions in short-term funding markets, which act as the indoor plumbing of the financial system, and this may require the Federal Reserve to take action relatively soon.
Two measures of funding-market liquidity, known as the Secured Overnight Financing Rate and the Tri-Party General Collateral Rate, have both crept back above 4% during the past week, but remain off their late-October peaks. Both rates are derived from the U.S. overnight repo market, which acts a critical source of short-term funding for a wide range of financial institutions. The Fed monitors pressures in the overnight repo market because of the potential for this to cause wider volatility.
“This, to us, looks like a repeat of the dynamics seen at October month-end,” said Sam Zief, global macro strategist and head of global FX strategy at J.P. Morgan Private Bank. In other words, these developments are “a sign of tighter funding conditions than investors have become accustomed to in recent years, but not a sign of widespread stress.”
Like the days that followed the end of October, “funding conditions are slowly normalizing this week,” Zief wrote in an email to MarketWatch on Tuesday. The bottom line is “liquidity conditions are tighter than they’ve been in recent years, so small shifts in supply and demand can create more visible volatility in money-market rates. That’s not unusual, but it feels more dramatic because we’ve gotten used to extremely stable rates in a world of abundant liquidity.”
