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Thu Sep 26, 2019, 11:15 AM

The NY Fed's rescue is working. But it hasn't fixed the market


New York (CNN Business)A crucial corner of Wall Street suddenly got very sick last week. The Federal Reserve responded with its favorite medicine: injecting markets with tens of billions of dollars of cash each day.

That emergency action from the New York Fed appears to have done the trick. The severe stress that emerged in overnight lending markets has largely faded. After spiking last week, borrowing rates have mostly gotten back in line.

But the cash crunch has only subsided because of all that free money being pumped in by the Fed. Without emergency cash injections, stress would probably return. Although the NY Fed's rescue is working, it hasn't fixed the underlying problem.
"It's like a painkiller. It works, but you're never really dealing with why the market is broken in the first place," said James Bianco, president of Bianco Research. "You're just medicating the market, you're not figuring out why the pain exists."

That pain could come back as the third quarter winds to an end next week. Liquidity normally dries up at quarter-end as banks pull back. And these aren't normal times.
"There is still a lot of caution and nervousness amongst many traders and clients," said Mark Cabana, rates strategist at Bank of America Merrill Lynch. "Quarter-end is a test."

Broken plumbing

Normally, Wall Street pays very little attention to the overnight lending markets. But that's not because they don't matter. Overnight lending markets are like the plumbing of US capital markets. They allow banks, hedge funds and other financial institutions to quickly and cheaply borrow money for short periods of time.

Investors were surprised to learn last week that the plumbing is broken. The rate on overnight repurchase, or repo, agreements surged to 5% on September 16. That's more than twice the target range for short-term borrowing set by the Federal Reserve.

In non-impeachment news, there are signs of weakness in our economy and the Fed doesn't seem to have explanations for it.

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