It remains to be seen if yesterday's action by the Fed is sufficient to regain control of the Repo rate. This is important, because a failure to control it will lead to some serious pain. The spike in interest rates will spread throughout the banking sector and into the broader economy.
The Repo rate is the base rate for all banking investments, which means that all bank loans are at some premium to this rate. Needless to say, a 10% base rate is way higher than what most borrowers can afford, so it can simply not be allowed to go this high. It must be kept lower.
Today will be extra interesting in this respect, because the Fed is set to lower their target rate from 2.25% to 2.00%. But this will be a meaningless gesture if the Repo rate is substantially higher. What good is a Fed target of 2.00% if the actual rate is consistently trading above 2.50%?
To remain credible, the Fed needs to bring the Repo rate down to its target rate. If they set their target to 2.00%, the Repo rate must be no higher than 2.25% or thereabouts. However, the only way to keep the Repo rate lower in times of stress is through massive injection of cash, which opens up for all sorts of other problems, including the possibility of a hyper-inflationary collapse. But such problems will emerge later, rather than sooner. Monetary injection will therefore be chosen, despite its dangers.
My guess is that the Fed chairman will announce a reduction of their target rate to 2.00%, and make some kind of statement regarding the resumption of their QE program. This should send the Repo rate down to about 2.25%. If not, a complete meltdown of the credit market may be at hand, with rates going up regardless of Fed words and actions.
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