Deciphering the Fed’s alphabet soup

16/12/2018 // by admin

The US Federal Reserve has an alphabet soup of financing facilities and so for investors trying to understand what’s happening it’s like having a second language. But it is getting complicated.
Nanjing Night Net

Prior to the global financial crisis the debate was normally over whether the economic recovery would be in the shape of a V, U, W or even a square root symbol, with some talk about a J-curve thrown in for good measure.

Then we got acronyms like QE (quantitative easing) and LTRO (long-term refinancing operations), as central banks became the dominant players in global financial markets, dictating all the ebbs and flows.

Now we have TDF, RRP and IOER. Or for those that aren’t bilingual, the term deposit facility, the reverse repurchase agreements and interest on excess reserves.

Those three acronyms just happen to be a large part of the latest strategy that the Fed has signalled it will use when it starts to get interest rates back to more normal levels.

Not that it’s going to happen anytime soon.

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But the latest minutes from this month’s meeting show that the members of the Federal Open Market Committee have all bases covered.

The FOMC even wants to give investors more information about how the Fed is going to dismantle its balance sheet that has blown out to more than $US4 trillion since the GFC.

The committee also want to make it very clear what happens when all the US Treasuries on the balance sheet mature and how the principal payments on MBS will be reinvested. That’s mortgage backed securities on the balance sheet.

The main message however was how the Fed, eventually, is going to get monetary policy back to normal when banks have trillions of dollars of excess reserves.

In the past, the Fed would just take away a small amount of those reserves and then rates would go up. But that’s not going to work in the world investors live in now.

That’s where TDF, RRP and IOER come into it.

All are new measures and no one is quite sure how they will work so the Fed will roadtest them before launching them, but if they have one thing in common it is all about giving the Fed more control over interest rates.

The Fed is about to embark on a program that enables the banks to park money with the bank for seven days, that’s the term deposit, at 0.25 per cent, which is at the top end of its current policy rate range.

This keeps the money away from the overnight market that dictates the Fed funds rate and is a way of soaking up the excess reserves.

The IOER right now pays 0.25 per cent so is a little sidelined by the seven day deal. Some analysts say the RRP is the better option for the Fed.

It, too, is a way of soaking up extra cash, but this time it’s not from the banks, but from government agencies such as Freddie Mac and Fannie May that have as much as $US24 billion in cash and money market funds, with $US2.6 trillion in assets, that can’t use the seven-day deals.

This money attracts a rate of 0.05 per cent.

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