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A GUIDE TO THE EVOLUTION OF OVERNIGHT LENDING MARKETS SINCE LIFT OFF (12/15)Before we get to lift off, let’s go to the spring of 2015 – see article: Click Here for Pressure in the REPO market spreads! and Here for DocSo the Fed created the Reverse Repo facility to give MMMF’s a place to park their cash – MMMFs will not accept a rate below the super safe reverse repo rate offered by the Fed – super safe since the Fed is using the GS (from QE1, 2, 3) as collateral! Recall, the reverse repo rate serves as a floor for the repo rate as long as it is encompassing enough (let all MMMFs access, very solid floor – let less access, weaker floor) Click Here for Fed Moves Toward New Tool for Setting RatesClick Here for list of reverse repo counterpartiesNote, shortage of Treasuries to act as collateral caused prices to rise, yields to fall into negative territory – worth noting – opposite of what is happening today (surplus (glut) of Treasuries- repo rates too high). LIFT OFF! DECEMBER 2015To replicate graph: google DFF Fred, edit graph: then add lines: type in “upper” then “lower” then “ioer” then change dates!A: AS YOU CAN SEE, THE FED KEPT ON RAISING THE RANGE AS THE ECONOMY GOT HEALTHIER – OF COURSE THE FF RATE IS DETERMINED BY THE IOR MINUS THE COA (COST OF ARBITRAGE). THE DOWNWARD SPIKES IN FF IS WHEN THE GSE’S RUN TO THE REVERSE REPO FACILITY TO DRESS UP THEIR BALANCE SHEETS AT THE END OF EACH MONTH TO SATISFY REGULATORS AND SHAREHOLDERS. Click Here for Interest Rate Control Is More Complicated Than You ThoughtB: AFTER THE MARCH 2018 MEETING WE NOTICE TWO DEVELOPMENTS: 1) THE DOWNWARD SPIKES DISAPPEAR – THE GSE’S ARE NO LONGER RUNNING BACK TO THE RRP FACILITY AT THE END OF EACH MONTH ….. WHY? THE REPO MARKET HAS COME BACK TO LIFE! – THE DEBT CEILING WAS RELAXED AND SHORT TERM TREASURIES FLOODED THE MARKET – GIVING THE BANKS AND HEDGE FUNDS THE COLLATERAL NEEDED TO DO REPOS! Click Here for As Fed Loses Control of Overnight Rates, Blame Shifts to T-BillsNOTE ALSO THAT THE COST OF ARBITRAGE HAS FALLEN – THE FF RATE IS BUMPING UP CLOSER TO THE IOR SINCE GSE’S CAN BE MORE PICKY GIVEN THE REBIRTH OF THE REPO MARKET. NOTE THE FOOTNOTE FROM GAGNON AND SACK (page 5) – FOR SOME -NO (OR VERY LITTLE) COA7. The FDIC fee varies across financial institutions, with a rate ranging from 5 to 45 basis points. Foreign banks do not pay the fee because they are not insured by the FDIC. As a result, they have become the primary borrowers of federal funds (Afonso, Entz, and LeSueur 2013b).THE FACT THAT THE FF IS SO CLOSE TO THE UPPER BOUND OF THE RANGE DOESN’T MAKE THE FED LOOK GOOD – SO THEY ARE GOING TO DO SOMETHING ABOUT IT!C: in June of 2018, the Fed raised the range again but behind the curtain (like the wizard of oz!:), the Fed tweaked the IOER by just raising it up by only 20 BP – so now, for the first time, the IOER is not the upper bound anymore – it is 5 BP below the upper bound – of course the strategy was to push the FF down towards the middle of the range. Click Here for The Fed’s Fight for Control of Its Key Interest Rate: QuickTakeD: At the Dec. 2018 meeting the wizard came out again (Dec 2018) and the Fed, when they raised the range by 25 BP, they only raised the IOER by 20 BP now placing the IOER 10 BP below the upper range – again in an attempt to look good – get the FF more in the middle of the range! Again, a clear sign that the Repo market is back! Note, this hike was quite controversial – along with Trump bashing the Fed via tweets, the market in Dec. 2018 was tanking – I think the Dow lost around 8% that month – could it be that the Fed hiked when they may not have really wanted to just so they could tweak the IOER to look better? I think maybe so – think about how confusing it would have been if the Fed said no change in FF target but we are lowering the IOER – no place for the wizard to hide! E: Oh boy, look at that, the FF is above the IOER – how could this be? My bet is that the Repo rates were higher yet giving GSE’s an attractive return – so why would the GSE’s settle for less if the repo rate was higher? Liquidity concerns – you get your cash back quicker when you play the FF market – so sacrifice a little return for more liquidity! SEE THE END OF ARTICLE BELOW! The 100 dollar question is who is borrowing off of the GSE’s in the FF market – my bet is that it is member banks – dealers – they are borrowing at the FF and then doing repos with hedge funds who are paying the higher repo rate – make sense???Also, the Fed lowered the IOER to 15 BP below the upper bound – again, trying to get the FF rate more in the middle of the range!Click Here for Interest Rate Control Is More Complicated Than You Thought E: Oh no! The FF popped up above its upper bound – call the authorities – the monetary authorities!:) What is happening here is that the repo market is hot – the GSE’s are getting a nice ff rate – but the repo rate must be even higher – so GSE’s are using the FF market for liquidity purposes (see above). Who is buying the cash? – the dealers – borrow off the GSE’s (at ff rate) and then do repos with hedge funds getting the higher repo rate. So the problem is that the Repo market is suffering from a glut (excess supply) of Treasury’s due in part to deficit spending – got to pay for the lower corporate taxes somehow – issue Treasuries!. F: The Fed lowered the range by another 25 BP but lowered the IOER by even more = 30 BP. Now the IOER is 20 BP below the upper bound and only 5 BP off the lower bound. WHY ? Again, repo market is hot! The idea is that if repo rates get high enough the dealers will arbitrage down the repo rate by lending cash to the hedge funds at the higher rate – if enough dealers conduct this arbitrage, then the repo rate will come down into the range set by the FED – after all, the Fed cares a heck of a lot more about the $3 trillion dollar repo market than the super boring (almost obsolete) FF market. G: The FF is back to equal the IOER = 1.55 only 5 BP off the lower bound – from 11/6/2019 to 11/28/2019 – the FF was constant at 1.55%. Why constant? – since I was in diapers I learned the when interest rates don’t move either 1) they are not market determined or 2) there is no trading – well, take a guess! No trading – repo market is so hot that GSE’s shun the FF market and the dealers aren’t using it since they are sitting on piles of ER. Yes, if the FF market isn’t dead – it’s got to be on life support!Final Comments – given that there is basically too many Treasuries out there and not enough cash which of course would lower prices and increase yields, what can the fed do about it??? Simple – back to standard open market purchases! Buy Treasuries, get them off the market and inject cash (ER). Have they been doing this – of course. In fact, they are doing this on a monthly basis to alleviate strains in the overnight lending markets! Got it? Just remember – its all about the repo rate – not the ff rate!The Fed Is Buying Bonds Again. Just Don’t Call It Quantitative Easing.Fed Adds $110.1 Billion to Financial System in Latest TransactionStatement Regarding Monetary Policy Implementation (Oct 2019) (FAQ about statement)Fed to Increase Supply of Bank Reserves ................
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