By business correspondent David Taylor, ABC
The New York Stock Exchange. Photo: AFP / Getty Images / Michael M Santiago
Early warning signs are emerging of the rising danger of another global credit crunch.
Analysts say recent moves by the US central bank to inject cash into the system could be a "canary in the coalmine", indicating growing financial stresses.
An extreme example of a credit crunch was the global financial crisis, which led to the collapse of US-based Lehman Brothers in September 2008.
In the days and weeks that followed, few banks would lend to one another for fear they would not get their money back.
It created a credit crunch or credit freeze, and what we now know as the Global Financial Crisis or GFC.
On 31 October this year, the Federal Reserve, equivalent to Australia's Reserve Bank, injected an impressive $US50.35 billion (NZ$89 billion) into the US financial system.
It was done via repurchase agreements or "repos".
It sounds complicated, but it is simple.
A major bank may be concerned that it does not have enough cash on hand to meet immediate requirements, like settling a transaction with another bank, for example.
It may then decide to offer the central bank, in this case the US Federal Reserve, a security, like a mortgage or bond, as collateral for an overnight loan.
The following day, the bank buys back, or repurchases, the mortgage or bond from the central bank, hence the term repo.
The US Federal Reserve headquarters in Washington. Photo: AFP
US has 'short-term' credit crunch
On Friday, the Fed's Standing Repo Facility lent that $US50.35b to eligible financial firms in two separate availabilities.
It was the highest-ever use of that facility since it was put in place in 2021 to provide fast loans collateralised with Treasury or mortgage bonds.
Marcus Today's senior portfolio manager, Henry Jennings, said the US banking sector experienced a "short-term" credit crunch on Friday.
"The plumbing of the US banking system was somewhat stressed at month-end," he said.
"We need to keep an eye on further moves but, for now, the market is more concerned with earnings than plumbing."
Jennings said money was draining from the US financial system, prompting the Fed to step in to top it up.
Asked by ABC News about the Fed's recent actions at Tuesday's press conference, RBA governor Michele Bullock responded, "I don't think there will be a credit crunch because I think that's exactly what the Fed is trying to avoid.
"The Fed have got themselves, as I think [Federal Reserve chairperson] Jay [Powell] set out, to a position now where they think their reserves are about as low as they can go without introducing difficulties in the money markets for banks trying to get liquidity.
"This is obviously part of their response to that."
However, some analysts are alarmed that the Federal Reserve has needed to step in at all.
"The question is whether this is another canary in the coalmine," Jennings said.
US Federal Reserve chairperson Jerome (Jay) Powell. Photo: AFP
Signs of tighter liquidity emerging
The Federal Reserve recently engaged in what is known as "quantitative tightening" or "QT".
It is where the central bank sells bonds and receives cash in return, or lets its bond holdings mature without buying more, thus reducing its holdings and effectively sucking money out of the economy.
However, at the same time, the US government is also selling bonds, or US Treasuries, to raise money to fund its ballooning budget deficit.
Analysts say it has put pockets of global money markets under strain and may explain why the US Federal Reserve recently announced an end to QT.
However, it has raised questions that the announcement may have been too late, with key gauges of secured borrowing having risen in the US and UK, reaching levels not seen in years.
While the drivers in each case may differ, the signs of tighter liquidity are flashing across markets.
In mid-October, Powell said "some signs have begun to emerge that liquidity conditions are gradually tightening, including a general firming of repo rates along with more noticeable but temporary pressures on selected dates".
The SOFR is the Secured Overnight Financing Rate. It is essentially the interest rate on the central bank's repurchase agreements.
The higher the SOFR, the greater the fear in the money markets of a credit crunch.
"That spike [in the Federal Reserve Repo facility] has gone hand in hand with a rising SOFR," Gerard Minack of Minack Advisers told ABC News.
"So there is some tightness in funding markets," Minack said.
"My sense is that some people are now on high alert for signs of a material pick up in stress indicators.
"But most of the market remains complacent."
Wall Street cash issues not one-off
But there is a twist to this story.
While the entire US Federal Reserve repo was roughly $US50b, the New York Federal Reserve (an arm of the US central bank) was the sole provider of this cash to the market on Friday.
While that is its job, the significance of this is that the New York Fed is considered the banker to Wall Street.
In very simple terms, analysts say, Wall Street ran short of cash on Friday night.
But it was not a one-off, end-of-month event.
The New York Fed followed it up on Monday with another $US22b injection of cash into Wall Street - accepting $US7.75b in US Treasuries and $US14.25b in mortgage-backed securities as collateral.
It is pushing up short-term interest rates as lenders grow anxious about whether they will get their money back from counterparties.
"US funding rates - a critical part of global financial plumbing - have been rising relative to the Fed-administered rates for a number of days," Jamieson Coote Bonds chief investment officer, Charlie Jamieson, said.
"There is no single causation for this; many have dismissed this as likely from month-end [bank cash settlement] or the settlement of [US Treasury auctions], but it is persisting, which signals some type of market stress.
"By ending quantitative tightening on December 1, the Fed will release some pressure here, but policy intervention should not be ruled out before that time - think quantitative easing."
"Quantitative easing" is the opposite of quantitative tightening - it is when the central bank buys bonds to inject liquidity, or cash, back into commercial financial institutions.
"Funding markets supply more than $US3 trillion in cash and liquidity per day," Jamieson said.
"Rising funding rates indicate scarcity of cash available to meet demand, which in turn can force deleveraging of assets."
"Deleveraging" is when banks or other organisations seek to reduce their debt exposures, generally through asset sales.
The Reserve Bank has said in the past that disorderly, or dislocated, markets pose a threat to Australia's financial stability, and so will no doubt be following developments on the US money markets closely.
-ABC
