High demand for bonds has had a big impact
Bank of Canada governor Tiff Macklem has addressed the ongoing liquidity challenges in the country's funding markets, attributing them to heightened demand for bonds.
The Canadian overnight repo rate average (CORRA) has consistently exceeded the central bank’s overnight rate target in recent weeks, prompting it to conduct a series of repo operations, according to a Bloomberg report.
During a parliamentary committee session, Macklem explained that the global bond rally has led to a surge in demand for fixed-income securities as investors seek higher yields in anticipation of future interest rate declines. This rush into fixed income, including the overnight market, has resulted in upward pressure on the CORRA rate.
"Some of that funding is in the overnight market, so it's creating some upward pressure," said Macklem, acknowledging that multiple factors may contribute to the current market tightness.
This was the first time Macklem publicly addressed the liquidity challenges and the central bank's actions taken in response. In the previous month, the Bank issued an explanation regarding its repo operations to dispel unfounded claims of financial stress in Canada's banking system.
Macklem emphasized that the central bank's actions aim to implement its intended monetary policy. CORRA is expected to closely align with the Bank of Canada's overnight-rate target. However, when liquidity decreases, the rising demand for cash can drive CORRA higher than the overnight rate as lenders seek greater compensation to release their funds.
Some analysts have suggested that the growing gap between CORRA and the overnight rate could signal a shortage of settlement balances used for payments in Canada's high-value payment system, Lynx. To address this issue, policymakers may need to reconsider the removal of these balances sooner than planned.
To stabilize the size of its balance sheet, the Bank of Canada could halt its quantitative tightening program and resume bond purchases. Senior deputy governor Carolyn Rogers, also present at the parliamentary committee, revealed that she had discussed the situation with counterparts at the United States Federal Reserve, indicating that similar challenges are emerging at other central banks worldwide.
“What we’re seeing happen in Canada is happening at other central banks,” Rogers said.
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