Secured Overnight Financing Rates Rise Back to Early Year Highs, Fed Needs to Restart Quantitative Easing to Fix Problems

On July 3, the secured overnight financing rate (SOFR) rose to 5.4% on Monday, matching the six-year high set on January 2, according to the Federal Reserve Bank of New York. The rate represents the cost to banks of borrowing cash collateralized by U.S. Treasuries overnight. The increase is indicative of tightening liquidity and restricted overnight borrowing, a market dynamic last seen in September 2019, after which the Federal Reserve injected liquidity into the repo market, where institutions borrow and lend money short-term using U.S. Treasuries as collateral.

David Brickell, an executive at Toronto-based crypto platform FRNT Financial, said the situation is something for the market to worry about in the short term. There could be some financing pressure after the end of the second quarter. However, this is reminiscent of the spike in repo financing rates we experienced in 2019, where we started to see pressure on excessive government debt and Treasury bill issuance. Eventually the Fed will need to end quantitative tightening or balance sheet contraction and restart liquidity injections similar to quantitative easing. The financial system cannot absorb this level of debt without Fed liquidity. Ultimately, the Fed will soon return to balance sheet expansion mode as the liquidity provider of last resort.