LISTEN TO ARTICLE 4:02 SHARE THIS ARTICLE Share Tweet Post Email

Photographer: DANIEL ACKER Photographer: DANIEL ACKER

Investors are eagerly lining up backup financing just in case the U.S. repo market, which worried Wall Street when it went haywire in mid-September, sees turmoil at the end of the year.

For the third straight Monday, the Federal Reserve conducted funding operations designed to give traders extra liquidity around Dec. 31, a time when repo liquidity has historically dried up. All three were oversubscribed, meaning market participants bid for more than the central bank was offering. The latest one got requests for $43 billion versus the $25 billion maximum.

Year-end isn’t the only challenge for a business that, among other things, is used to finance the purchase of Treasuries. Pressure could also resurface around Dec. 16, when new U.S. debt is distributed to investors, while at the same time quarterly corporate tax payments push up the Treasury Department’s cash balance.

That money is parked at the nation’s central bank, and increases to that amount are generally matched by decreases in the balances of other institutions with deposits at the Fed -- in other words, banks. So while the Fed is currently seeking to bolster bank reserves to calm funding markets, an increase in the Treasury’s cash balance could stir up trouble.

“There will be pressure in the middle of the month, just like there will be pressure at the end of the year,” said Mark Cabana, head of U.S. interest rate strategy at Bank of America Corp. He expects usage of the Fed’s overnight repo operations to increase on Friday, Monday and Tuesday. While there will be “some signs of stress,” the presence of the Fed in the market means that there’s unlikely to be a repeat of September’s turmoil, he added.

The payment of corporate taxes in mid-September was one of the factors highlighted by many observers as potentially contributing to the spike in repo rates around three months ago. In response to that upheaval, which saw the overnight rate for general collateral repo climbing to 10% from around 2%, the Fed started injecting liquidity into the repo market from Sept. 17. It has also been buying Treasury bills to add reserves to the system.

The Federal Reserve Bank of New York’s 28-day operation on Monday -- which matures on Jan. 6 -- was the last of three term operations currently scheduled to provide funding past year-end. Traders will be watching for any announcements from the central bank about plans for additional term-repo operations beyond the 13-day and 14-day actions scheduled for later this week. The next release of details is due to take place Thursday.

The size of the Dec. 9 operation was increased last week to $25 billion from its initial amount of $15 billion after the central bank’s second year-end offering was oversubscribed. Market participants had submitted $42.55 billion in bids for the 42-day term action that took place a week ago, which was more than the $25 billion available. That term offering had also been upsized after the bids for the Fed’s first year-end operation on Nov. 25 exceeded the amount offered.

BMO Capital Markets Strategist Jon Hill said that while he’s neither surprised by the takeup for the most recent term action nor worried at this stage, it would be “concerning” if term operations are still oversubscribed when Dec. 26 rolls around. “If it’s looking scary, the Fed could do more.”

The recent tumult has spurred debate about the causes of friction in the repo market and potential solutions. The Bank for International Settlements on Sunday released a report suggesting that there is a structural problem in the market and that it wasn’t just a temporary hiccup. A group of smaller broker-dealers, meanwhile, has proposed several options to reduce how much the funding market relies on just a few players.

— With assistance by Benjamin Purvis, and Debarati Roy