New York Fed’s Williams prepares markets for “technical adjustments” to the Fed’s “administered interest rates” to get a handle on this phenomenon.
By Wolf Richter for WOLF STREET.
The Fed sold a record $503 billion in Treasury securities this morning via overnight “reverse repos” (RRP) to 59 counterparties, and thereby took in $503 billion in cash from the counterparties. These overnight RRPs will mature and unwind tomorrow. Yesterday’s record $497 billion in overnight RRPs matured this morning and were replaced by this new and even larger flood.
“Reverse repos” are the opposite of “repos.” They drain cash from the market and are liabilities on the Fed’s balance sheet – money the Fed owes the counterparties.
A similar phenomenon, but on a smaller scale, occurred starting in 2014 as the US financial system was awash in cash following years of QE. And at the end of the quarter, particularly at the end of the year, RRP balances spiked. The phenomenon declined as the Fed began shedding its assets from late 2017 to 2019. But this time overnight RRPs spiked beyond those levels during the middle of the quarter – with June 30 coming up:
By having drained $503 billion in cash from the market via these overnight reverse repos, the Fed has undone the liquidity effect of 4.2 months of QE, which continues at a rate of about $120 billion a month.
The coming “technical adjustments” to the Fed’s administered interest rates.
The Fed’s offering rate currently for overnight reverse repos is 0%, meaning that counterparties are handing their cash to the Fed, and get Treasuries as collateral, for 0% return. The offering rate is decided by the FOMC. The Fed offers these reverse repos to keep the reverse repo rates from falling into the negative as the tsunami of liquidity needs to find a place to go.
The Fed could get a handle on this liquidity phenomenon by tapering asset purchases and eventually reducing its balance sheet. That’s how the phenomenon was resolved last time.
This reverse repo offering rate is now getting lined up for what the Fed calls a “technical adjustment,” namely an increase of something like 10 basis points, either at the next FOMC meeting or at an in-between Zoom meeting before then.
The Interest on Excess Reserves (IOER) could also be subject to this type of “technical adjustment.” The Fed is currently paying the banks 0.1% interest on cash they put on deposit at the Fed. Those “reserves,” as that cash on deposit at the Fed is called, now stand at $3.8 trillion.
The FOMC may also hike the IOER by some basis points. This would help raise the floor of the effective federal funds rate to where it trades closer to the middle of the Fed’s target range, (0.00% to 0.25%). The effective federal funds rate has been around 0.06% when it should be around 0.12%.
So New York Fed President John Williams, whose outfit handles the Fed’s trading activities, prepared the markets for this type of “technical adjustment” to the Fed’s reverse repo offering rate and the IOER in an interview with Yahoo Finance last week.
He emphasized repeatedly that the reverse repo system “was working really well,” and “exactly as designed,” that there were “really, no concerns about that.” And he also shed light on where this tsunami of liquidity came from that the Fed took in: the “banking system.”
So he explained: “When we thought about and set this up [the reverse repo facility] a long time ago, we wanted to make sure, in a situation where we’re making asset purchases for our monetary policy goals, that the matching increase in liabilities would be distributed in the financial system efficiently and well. And a lot of it shows up in the banking system as reserves, but also some of it can show up through the overnight reverse repo facility.”
“And we have seen that get used quite a bit recently. We expected that to happen. It’s working exactly as designed. Really, no concerns about that. It’s a system that was put in place so that we didn’t have problems [INAUDIBLE], and we’re not having them,” he said.
“So to me, it’s working really well, and the fact that funds are flowing between the banking system and the overnight reverse repo, this is kind of what we would expect to happen in this kind of circumstance,” he said.
“And we actually, going back to earlier days, we’ve made adjustments, technical adjustments to these administered rates and these programs, specifically to make sure they’re working well. And for me, achieving the FOMC’s goal of having the federal funds rate trading well within the target range,” he said.
“So we have the ability to adjust parameters of our administered rates or other parts of our program so that they work really well and keep interest rates where we want. So we can do that if that’s called for,” he said
“We have the ability to tweak it, if you will, to make sure it’s achieving exactly what the FOMC is looking for in terms of short-term interest rates,” he said.
So these administered rates may be in for some “technical adjustments” upward at or before the next FOMC meeting. And this would be underlined by some taper talk. And meanwhile, the Fed is starting to sell its holdings of corporate bonds and corporate bond ETFs.
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