Fed to Lower Interest Rates Due to Market Pressure

Concerns are growing on Wall Street as executives anticipate a potential tantrum in US short-term financing markets, with some speculating it could unfold as early as March. The confluence of events expected between March and May could exert pressure on the Federal Reserve to reconsider its policy stance.

A Fed lending facility, established in response to the regional banking crisis last year, is set to expire in Mar. 11, with US$129 billion outstanding. This will eliminate a key funding source for banks. Additionally, the standing repo facility (SRF), positioned as a safety net by Fed officials, has seen limited participation from banks, according to Reuters. 

This unfolds as the Fed continues to reduce cash in the financial system by unwinding pandemic-era support, with BNY Mellon strategists estimating a potential dip below US$200 billion in cash parked overnight with the Fed by May, a fraction of last year's levels.

Market participants are expressing concerns about potential stress in short-term financing markets, particularly in repurchase agreements (repo), where interest rates spiked briefly at the end of November and December. This has brought liquidity concerns into sharper focus, raising questions about the resilience of funding markets.

The risk of a policy error is also increasing as the Fed approaches its target inflation rate of 2%. A market meltdown could signal to the Fed the need to ease policy, potentially slowing the pace of quantitative tightening.

As the Fed waits on this decision, Mexico’s Central Bank (Banxico) is also awaiting a change in interest rates that could affect the country’s financial institutions.