Fed Confirms That Federal Borrowing a Cause of Liquidity Crisis

Robert Kaplan, the president of the Federal Reserve Bank of Dallas, has confirmed that the surge in U.S. government borrowing in September 2019 was a primary cause of the liquidity crisis affecting the nation’s money markets. Reuters reports that revelation from Kaplan’s speech on Friday, October 11, to the Commonwealth Club of San Francisco:

Dallas Federal Reserve Bank President Robert Kaplan on Friday blamed U.S. borrowing to fund a growing deficit for the liquidity crunch in overnight funding markets that the central bank earlier on Friday addressed with a new program to buy Treasury bills.

“The dramatic increase in Treasury issuance takes liquidity out of the system,” Kaplan said at the Commonwealth Club. “That I think is at the top of the list for reasons we need more liquidity.” The other reason, he said, is post-financial-crisis regulation that forces banks to hold more reserves.

Kaplan said the liquidity issue the Fed is addressing is not a sign of a bigger problem and the action the Fed is taking to address it is technical and separate from monetary policy.

On Friday, the Fed also announced it would buy at least $60 billion of short-term Treasuries each month into the second quarter of 2020. That decision followed an unscheduled meeting by videoconference a week earlier to address the developing liquidity crisis.

ZeroHedge argues that the Fed’s plans to resume loaning new money to the U.S. government by buying up its newly issued T-bills is a sign of a bigger problem:

That this took place after quarter-end, when the Fed had already announced a generous menu of repo unclogging operations, including a barrage of term repos in addition to the expanded, $100BN overnight repo, confirms just how seriously the Fed took the mid-September freeze of overnight funding markets (which sent G/C overnight repo rates to 9.25%), and is proof that – contrary to what many central bankers said last week – this was far more than a mere “plumbing” hiccup.

ZeroHedge also argues that the Fed’s emergency liquidity injection, combined with rate cuts and its additional purchases of U.S. Treasuries, constitutes the return of quantitative easing.

If not for the worst budget deal in history, the repo market’s liquidity crisis would not require up to half a trillion dollars of loans from the Fed to sustain the U.S. government’s excessive spending to compensate.