Fed's U-turn on assets faces a year-end test, - WSJ

The WSJ reports the Fed over the last three months has flooded money markets with hundreds of billions of dollars in cash to avoid a repeat of volatility that roiled cash markets in September.

The success of the moves, which reversed roughly half of the Fed's shrinkage of its asset portfolio over the prior two years, will encounter a test around December 31, when some financial institutions could face incentives from regulations to limit their lending, which could cause supply and demand imbalances for cash.

Fed officials have said they believe deposits by banks held at the Fed, called reserves, grew scarce enough in mid-September to put pressure on an obscure but important lending rate in the market for repurchase agreements, or repos. Banks and other firms use repos as a way to borrow cash for short periods, pledging government securities as collateral.

To prevent a squeeze from happening again, Fed officials have been buying short-term Treasury bills from financial institutions to put more reserves back into the financial system. They also have conducted daily injections of liquidity into markets.

Altogether, those operations could add nearly $500 billion in net liquidity to markets around December 31.

The end of the year is an important date because large banks could limit lending activities in derivatives and repo markets to guard against extra regulatory burdens. For these banks, their lending profile on December 31 is used to determine how much equity capital they must raise against their liabilities.

In the last few years, repo rates have typically been no more than a 10th of a percentage point above or below the Fed's benchmark rate, but on December 31, 2018, they widened by 2.75 percentage points.