The Federal Reserve held a "temporary meeting" on Wednesday to discuss "market liquidity pressures" with Wall Street banks

The New York Federal Reserve held an unscheduled meeting with major Wall Street banks this week, highlighting officials' concerns about the tightening of the U.S. money market.

On November 14, media reports citing three informed sources revealed that during the Federal Reserve's annual Treasury market meeting on Wednesday, New York Fed President John Williams convened a meeting with Wall Street banks.

The core agenda of the meeting was to solicit feedback from primary dealers (i.e., banks that underwrite government debt) on the usage of the Federal Reserve's standing repurchase agreement facility. Central bank officials stated that this facility is an important pressure relief valve that helps keep short-term borrowing costs within target ranges.

Reports cited informed sources indicating that many of the 25 primary dealers sent representatives to attend. They noted that most attendees were members of the banks' fixed income market teams.

This move comes as key indicators measuring short-term borrowing costs have repeatedly surged above the interest rate levels set by the Federal Reserve, raising market concerns about liquidity conditions.

Analysts warned that the market is expected to face more pressure in the coming weeks. A key backdrop is that, after three years of quantitative tightening (QT), excess cash in the banking system has significantly decreased.

As the year-end approaches, this situation is expected to worsen. For financial reporting purposes, banks typically reduce their balance sheet sizes at year-end, which may exacerbate cash tightness in the market.

Reemergence of Funding Market Pressure

Recently, signals of pressure in the U.S. money market have repeatedly drawn attention.

As a closely monitored short-term borrowing cost indicator, the tri-party repo rate rose again this week, briefly exceeding the Federal Reserve's reserve balance rate by nearly 0.1 percentage points, although it remains below the peak at the end of October.

Roberto Perli, head of market operations at the New York Fed, acknowledged this week that some borrowers have been struggling to secure repo funding at levels close to the central bank's reserve balance rate. He pointed out:

The share of repo transactions conducted at rates above the reserve balance rate has reached the highest level since the end of 2018 and 2019.

Repo transactions are a crucial "lubricant" for the financial system, where traders exchange high-quality collateral for short-term cash. Therefore, their interest rate levels become key indicators closely monitored by policymakers.

At the end of last month, the tri-party repo rate surged significantly but subsequently eased due to the Federal Reserve's commitment to halt balance sheet reduction on December 1.

A "Safety Valve" with High Expectations but Poor Utilization

In the face of potential liquidity tightness, Federal Reserve officials view the Standing Repo Facility (SRF) as a key "pressure relief valve" aimed at keeping short-term rates within target ranges.

Williams and other senior officials insist that the SRF will be an important tool for alleviating pressure. Williams stated earlier this week:

The recent usage of the Standing Repo Facility (SRF) has been effective, and it is fully expected that it will continue to be actively used to curb upward pressure on money market rates Despite some institutions using this tool, the scale is insufficient to fully stabilize the repurchase rate.

One core obstacle to the low usage rate of the SRF is that lending institutions are generally unwilling to use this tool, fearing it may send a negative signal to the market that their institution is under pressure, known as the so-called "stigma" concern.

Although the names of institutions using this tool will not be disclosed until two years later, market participants' concerns about immediate reputation run deep. Thomas Simons, Chief U.S. Economist at Jefferies, stated:

The key to repurchase transactions is trust.

He added:

If any borrower is labeled as high risk, it creates a distorted incentive mechanism, causing all lending institutions to withdraw loans simultaneously, even if such withdrawal is not reasonable. Once reputation is damaged, it is difficult to recover