In an interesting article published yesterday in Bloomberg, “Repo Rate Rise Gives Nod to Fed Tool in Eventual Policy Reversal,” Liz McCormick quotes several economist and fixed income strategists who think that the Fed’s Reverse Repo Facility is having an effect on the market. Since we just published a report on this topic ourselves (“The Federal Reserve, Reverse Repo, Collateral and Benchmarking“), we had a thing or two to add.
Here are the quotes we noticed most:
Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC and a former Fed economist: Movements in repo rates are “qualitatively consistent with what we expect would happen once they do start using this in volume. The facility will be a potentially very significant enforcement to a floor for money market rates.”
There’s no question about it. You can’t go lower than the Fed and do any business.
Carl Lantz, head of interest-rate strategy at Credit Suisse Group AG in New York: “…the facility also opens the door for the Fed to cut the rate it pays on excess reserves. We think they are probably going to start considering bringing these rates into line.”
As soon as the Fed’s reverse repo rates inch close enough to IOER, the house of cards that is the Fed Funds rate will crumble. Here’s a short write up from the Fed’s Liberty Street blog that explains the problem.
Subadra Rajappa, a fixed-income strategist at New York-based Morgan Stanley: “The reverse-repo facility makes a lot of sense as a way to set a floor under money market rates and is already somewhat succeeding in pushing front-end rates higher.”
McCormick notes that the GCF index shows rates about 1/2 a bp higher since the start of the RRF. Not huge but potentially a foreshadowing of things to come.
On top of this, some interesting commentary from the Federal Open Market Committee in late October: “Most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions. By contrast, participants expressed a range of concerns about using open market operations aimed at affecting the expected path of short-term interest rates, such as a standing purchase facility for shorter-term Treasury securities or the provision of term funding through repurchase agreements. Among the concerns voiced was that such operations would inhibit price discovery and remove valuable sources of market information; in addition, such operations might be difficult to explain to the public, complicate the Committee’s communications, and appear inconsistent with the economic thresholds for the federal funds rate.”
So there are concerns about lowering IOER because it wouldn’t do much but also concerns about raising the RRF activity because it would do too much. It will be interesting to see what happens with the RRF come the end of this month. If we see another spike like what happened on Sept 30 (US$58 billion repoed out), that would suggest sustained demand for the facility relative to broker willingness to repo out overnight treasuries at higher rates. Is that market impact? In a world where treasury liquidity dries up at quarter end due to regulatory capital issues, it sure looks like it.