If the Fed is about to pivot to rate cuts and risks to the banking system ease, there may be no need to extend this emergency liquidity relief facility.
An enticing risk-free arbitrage opportunity is coming to an end after the Federal Reserve's top banking regulator said it was unlikely to extend an emergency liquidity rescue facility put in place during last year's banking crisis.
Michael Barr, the Federal Reserve's vice chair for supervision, said at an event on Tuesday that the Bank Term Funding Program (BTFP) was "actually established as an emergency program" that supported lenders during that turmoil. The BTFP is set to expire on March 11 and currently has a balance of about $140 billion。The program has attracted a large number of users in recent weeks, as traders look to lock in loans at more attractive interest rates.
Barr's remarks came a day after Fed Governor Bowman noted in a speech that the BTFP would end in a few months, causing an uproar in the market, which was widely believed to be a sign that the program would not be extended.
Usage of BTFP has soared to all-time highs in recent weeks, raising a troubling question for the Fed: whether banks should be allowed to continue arbitraging in this way.
Steven Zeng, a strategist at Deutsche Bank, said: "This (the end of the BTFP) shouldn't come as a surprise to anyone, but in my opinion, the earlier than expected announcement suggests," said Steven Zeng, a strategist at Deutsche BankThe Fed does have limited tolerance for banks profiting from the emergency bailout.
BTFP allows banks and credit unions to borrow money for up to a year against U.S. Treasuries and agency bonds. According to the latest data from the Federal Reserve, the use of the program hit a new high of $141 billion in the week ending January 3.
That's because the BTFP rate (calculated as a one-year overnight index swap plus 10 basis points) has fallen as traders ramp up their bets on a Fed rate cut in 2024. Eligible financial institutions have found it cheaper to borrow cash through this mechanism, with an interest rate of around 493%, but also the opportunity to deposit cash into an account with the Federal Reserve at an interest rate of 540%。
After the collapse of Silicon Valley Bank, the Federal Reserve activated the BTFP under an emergency mandate. Since the launch of the program, concerns about bank deposit flight and unrealized losses have eased. The Fed** is also working to steer financial institutions to other lending facilities, including the oft-criticized discount window and standing repo facility.
But that hasn't affected the appeal of BTFP. Moreover, in order to support the reserve balance,Banks are likely to continue to take advantage of this scheme until it expires.
Mark Cabana, head of U.S. rates strategy at Bank of America, said: "Banks are choosing to further build liquidity buffers in response to the maturity of the mechanism. But think about it,If the Fed moves in the direction of cutting interest rates and the risks to the banking system ease, will it be necessary to renew this mechanism in the first year?