By Jonnelle Marte, Ann Saphir and Megan Davies
The New York Fed had to intervene in cash markets this week when the repo rate, a key measure of liquidity in the global banking system, sky-rocketed, forcing the Fed to make an emergency injection of more than $125 billion on Tuesday and Wednesday. A key interest rate the Fed aims to influence also broke above the central bank’s target range on Tuesday for the first time since the financial crisis.
“What has happened in the repo market is far from a minor problem,” said Ward McCarthy, chief financial economist for Jefferies. “That’s a financial crisis waiting to happen if they don’t get that under control.”
As the head of the New York Fed, Williams has the unique task of overseeing regulation of Wall Street and execution of monetary policy. The 57-year-old veteran economist, who was previously president of the Federal Reserve Bank of San Francisco, has a resume that diverges from some of his predecessors who came to the job with years in the financial sector.
Some investors and economists who regularly interact with the New York Fed said Williams and his staff could have better prepared for the factors that likely led to this week’s liquidity crunch, which included larger-than-expected issuance of Treasury bonds and a surge in quarterly corporate tax payments.
The bank took no action on Monday when the repo rate first increased and faced technical problems on Tuesday that delayed the repo operation by half an hour.
Fed Chair Jerome Powell defended the central bank’s response to the liquidity crunch on Wednesday, saying officials saw the cash shortage coming and “took appropriate actions” to address the issue.
“We don’t see this as having any implications for the broader economy,” Powell told reporters after the Fed announced at the close of a two-day policy meeting that it would reduce its benchmark overnight lending rate to a range of 1.75% to 2.00%. “We took appropriate actions to address those pressures and those measures were successful. If we experience another episode in money markets we have the tools to address those pressures.”
A spokeswoman for the New York Fed declined to comment beyond Powell’s remarks.
More information is needed to assess whether the moves are a sign of a broader problem, other investors said.
“It’s probably nothing,” said Willie Delwiche, investment strategist for Baird. “But there is a risk that there is some trouble in the monetary plumbing in the economy.”
Complicating matters is the recent departure of two key markets experts, leaving vacancies at the New York Fed that some worry may have slowed down the U.S. central bank’s response to the volatility this week.
The two market-focused officials abruptly departed in June: Simon Potter, who oversaw the New York Fed’s trading desk, and Richard Dzina, who ran the bank’s financial services group. To date, neither has been replaced, leaving the central bank without permanent leadership in a key part of its operations.
Williams has spent decades analyzing, and in some cases, reshaping, monetary policy. In the early 1990s, as a Stanford University graduate student, he worked closely with influential economist John Taylor on a seminal paper that to this day remains a benchmark for rate-setting at the Fed.
He became an economist for the Federal Reserve in Washington in 1994, and in 2002 moved to the San Francisco Fed, rising through its ranks to lead the research department and then, in 2011, to head the bank after its president, Janet Yellen, became the Fed’s No. 2 policymaker in Washington.
But the native of Sacramento, California, a Star Wars fan and a collector of sneakers, never worked at an investment bank or on a trading desk, unlike his predecessor at the New York Fed, William Dudley, who was a managing director at Goldman Sachs (NYSE:).
“He will have to rely on the expertise of others to accomplish this central task,” the Brookings Institution’s Peter Conti-Brown wrote in a critical essay shortly after Williams was appointed to the New York Fed in 2018.
Williams inadvertently roiled markets in July when investors interpreted his remarks on research about how the Fed should operate in a low-rate environment as a full-throated call for policy-makers to move quickly and aggressively.
Markets viewed his comments that central banks should act “at the first sign of economic distress” as a sign that the Fed would cut its benchmark interest rate by 50 basis points. In an unusual move, the Fed issued a clarifying statement later that afternoon saying that Williams was speaking about 20 years of academic research, not sending a signal about future policy actions.
The New York Fed’s evolving reactions this week show that Williams and his staff are responding to markets more quickly, said Tom Simons, a senior money market economist for Jefferies.
While Tuesday’s repo operation arrived a “little bit later than would have been ideal,” the team responded in a more timely manner on Wednesday, Simons said.
The Fed was smart to announce late Tuesday that the move would be coming the following morning, a decision that was likely made after it became clear the effective funds rate was going to trade above the Fed’s target range, Simons said. Traders took full advantage of the cash injection on Wednesday.
“I think that’s a vote of confidence that they do have the staff together to handle these sorts of things,” he said.
Another repo operation is scheduled for Thursday morning.