The blog Sober Look caught an interesting item in the July Fed Open Market Committee report yesterday. The Fed is investigating creating “a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates”. This is a potential game changer.
The Fed minutes included this language:
“…In support of the Committee’s longer-run planning for improvements in the implementation of monetary policy, the Desk report also included a briefing on the potential for establishing a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates. The presentation suggested that such a facility would allow the Committee to offer an overnight, risk-free instrument directly to a relatively wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks and thereby improving the Committee’s ability to keep short-term market rates at levels that it deems appropriate to achieve its macroeconomic objectives. The staff also identified several key issues that would require consideration in the design of such a facility, including the choice of the appropriate facility interest rate and possible additions to the range of eligible counterparties. In general, meeting participants indicated that they thought such a facility could prove helpful; they asked the staff to undertake further work to examine how it might operate and how it might affect short-term funding markets. A number of them emphasized that their interest in having the staff conduct additional research reflected an ongoing effort to improve the technical execution of policy and did not signal any change in the Committee’s views about policy going forward…”
Sober Look noted that this could provide three objectives (we paraphrase and, of course, comment):
1.) By potentially including a broader range of counterparties, it creates a substitute for insured bank deposits. The investment would be risk-free.
This sounds a lot like a reincarnation of the Transaction Account Guarantee (TAG), except this time no bank involvement. If corporates, for example, have access, there will be little reason to invest in repos through dealers. The deposit parceling business may become very challenging. It will certainly make the government money market funds happier.
2.) The Fed would have another tool above and beyond IOER.
We wonder if the rate will match IOER? Will this simply be a way to cast a bigger net for the Fed to use to drain cash from the system? They already have broadened out their list of eligible counterparties past the primary dealers and include money market funds — but this could allow more consistent access. Is this about the Fed adding to the tools to manage their funding mismatch (QE assets vs. IOER deposits)?
3.) By using a repo scheme to hoover up cash, it sterilizes some of the Fed’s securities holdings. Moving these rates around can fine-tune the facility and avoid having to sell securities to drain liquidity.
If rates rise enough, the QE portfolio – which is already extended thanks to Operation Twist and full of mortgage paper that is negatively convex – might start to lose money. The Fed has been banging the drum on this recently. Additional ways to fund the securities might seem a better idea than selling. And the Treasury probably really likes all that carry.
The dealers probably won’t be crazy about the idea – it could be seen as competition.
We want to think about this some more and welcome your comments.
A link the July Fed Open Market Committee report is here.
A link to the Sober Look post is here.
A link to the Fed release on adding reverse repo counterparties is here.