The Fed rate-hike may have been priced in by the market, but what are the chances the market really priced in the effects of the rate-hike on the plumbing of the financial system, in particular with respect to the initiation of the unlimited RRP facility?
A report from Credit Suisse’ Global Rates Strategy team provides food for thought on Thursday.
For example, while we’ve already discussed the prospect of safe-asset starved MMF funds deploying en masse to the RRP facility, there’s an important nuance to be noted with respect to the winner funds and the loser funds in this new money-market paradigm.
From CS (our emphasis):
We expect that government-only money market funds are likely to see an inflow of $600bn-$1tn, while institutional prime funds could lose between $300-$500bn over the course of the year.
The rate hike was all priced in. They said.
But might everyone who made this purchasing decision just before Christmas live to regret it?
FT Alphaville has tackled the issue of an explosion of settlement fails in US Treasury markets before, referencing how fails seem to balloon in times of crisis, such as the 2008 global financial crisis, when the incentive not to deliver owed-securities increases — a stealth form of financing in the view of some observers.
It’s precisely the sort of behaviour that the TPMG fails charge, introduced in May 2009, was supposed to nip in the bud by making it too costly to neglect to deliver a security. Yet, despite having quelled the number of UST fails when it was first introduced quite successfully, its capacity to serve as an effective fail deterrent seems to be slipping. Read more
Credit Suisse’s Zoltan Pozsar, shadow banking and all-round financial plumbing expert, has crunched the ways the Wednesday’s Fed rate hike is likely to impact the underbelly of the financial system and notes the biggest outcome is probably the entry of some very hungry money market funds into the Fed’s $2tn RRP facility:
Money funds are getting ready to bid away hundreds of billions in non-operating deposits from banks and invest those funds in reverse repos at the Fed. The more generous these funds are in passing on the first hike, the more deposits they will lure away from banks and the greater the usage of the RRP facility. Banks on the other side of these flows are about to learn the validity of their assumptions regarding deposit betas (how deposits will respond to higher rates) and the liquidity profile of the high-quality liquid asset (HQLA) portfolios built based on these assumptions.
Tick tock. Tick tock. Just a few hours away from the Fed statement of the post-GFC-crisis era.
History never repeats and most analogies are wrong, but there are some intriguing parallels between the global macro environment in 1997-8 and today.
Back then, the Federal Reserve controversially chose to ease policy, first by refraining from rate hikes anticipated by the markets and then by cutting its target for Fed funds by 75 basis points. Many believe this choice inflated equity prices and encouraged excessive business investment at a time when America’s economy was already running hot. Despite the subsequent fillips of tax cuts, a boom in defence spending, and a housing bubble, the aftermath was a massive decline in employment and painfully slow recovery.
A simple comparison between conditions then and now suggests the Fed’s explicit desire to “normalise” financial conditions may come from a desire to avoid repeating the experiences of the late 1990s. Whether policymakers are right to prioritise the real economic data, which tells us what’s already happened, over the action in the financial markets, which tends to affect what will happen, is anyone’s guess. Read more
While you wait for the Fed’s actual implementation note — which will presumably follow its first rate rise since 2006, ‘due’ on Wednesday — here’s some useful guesswork from BNP Paribas:
Do click to enlarge. Read more
Forward guidance under Ben Bernanke and then Janet Yellen has been… changeable, notes David Kelly, chief strategist for JP Morgan Asset Management, who shares a reminder of the shifting timescale.
Here’s the Federal Reserve on when it would be appropriate to raise the target range for the federal funds rate:
January 2009 — not “for some time”
March 2009 — not “for an extended period” Read more
Previously of the NY Fed markets team and now at Credit Suisse, nobody knows repos and shadow banking like Zoltan Pozsar. In his latest co-authored piece with James Sweeney he takes a closer look at how an eventual Fed rate liftoff may play out technically on the ground.
As has been widely reported, the Fed is expected to utilise Reverse Repo (RRPs) facilities with non-bank money market funds as part of its unwind procedure. This is unprecedented to a degree, for it represents the effective expansion of the Fed’s balance sheet beyond the official bank sector.
By offering deposit services to non-banks at positive rates, the Fed will be pulling liquidity from the system by way of transforming excess reserves currently sitting on the books of the formal banking sector into non-bank reserve assets. While the overall amount of liquidity in the system will technically remain the same, what will change is who owns the liabilities. Read more
After a considerable period of boredom, trying to figure out America’s central bank has gotten interesting again.
For months, the mid-September meeting of the Federal Open Market Committee was being telegraphed as the most likely start date of the “normalisation” process. Or, to use another bit of central banker-ese, the day when short-term interest rates would begin “liftoff” from the current range of zero to 25 basis points. Read more
On June 29, someone at the Fed inadvertently included the staff’s June economic projections, which are supposed to be secret, into publicly available computer files. On July 24, the Fed decided to let the world know that it goofed, while also letting you download the charts and tables for yourself. Then it turns out that some of the information released was incorrect and had to be updated yet again.
For convenience, here’s a link to the table, which is somewhat useful to compare to the published projections of FOMC members. You’ll notice that the staff is much more pessimistic about real growth for 2015 than the entire range policymakers, and more pessimistic for 2016 growth than most policymakers polled for their projections. Otherwise there isn’t much new there. Read more
Judgment from the United States Court of Federal Claims on the AIG lawsuit:
Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan…Moreover, there is nothing in the Federal Reserve Act or in any other federal statute that would permit a Federal Reserve Bank to take over a private corporation and run its business as if the Government were the owner. Yet, that is precisely what FRBNY did.
It is one thing for FRBNY to have made an $85 billion loan to AIG at exorbitant interest rates under Section 13(3), but it is quite another to direct the replacement of AIG’s Chief Executive Officer, and to take control of AIG’s business operations. A Federal Reserve Bank has no right to control and run a company to whom it has made a sizable loan.
It’s from Michael Hartnett, of BoA Merrill Lynch, but you probably would have guessed that if asked.
My Big, Fat Greek Dreading (and other risks)
To the upside: concerns over Greece prove misplaced, investors over-hedge Fed risks, passage of TPP boost investor & corporate confidence, tech’s creative disruption = higher PE, lower CPI. To the downside: inflation surprises to upside.
Hartnett doesn’t have much to add specifically on Greece, other than this intriguing chart. Read more
It might not be polite to say it overtly, but concerns are growing that the Fed’s rate hiking promises may be nothing more than a big bluff.
The vogue for doubting Fed rhetoric started in earnest on March 11, when Ray Dalio, founder of hedge fund firm Bridgewater Associates, wrote to investors that there was a risk if the Fed raised rates too fast it could create a market rout similar to that of 1937. Read more
We know there’s been a great deal of change on the asset-side of banks’ balance sheets since the crisis. But if you ever wanted it summed up in one table, look no further than the following:
Eric Rosengren, the President of the Federal Reserve Bank of Boston, gave a speech in Frankfurt on Thursday arguing that the Fed’s full employment mandate gave the central bank more flexibility to be aggressive earlier, and that open-ended programmes that are tied to economic targets are more effective than purchases of predetermined size and duration.
Nothing novel there. But his speech also contained, perhaps inadvertently, some interesting arguments that the rounds of bond-buying after the acute phase of the financial crisis did little for the real economy. (We covered the tenuous relationship between asset purchase programmes and inflation here.) Read more
Narayana Kocherlakota, president of the Minneapolis Fed, today announced he will step down in 2016.
“Earlier this week, I informed the board of directors of the Federal Reserve Bank of Minneapolis that I do not intend to seek reappointment to a new term as president of the Bank after my current term ends on February 29, 2016,” Kocherlakota said. “I became president of the Minneapolis Bank in October 2009 so that I could be of service to my country in an economic emergency.
I have been honored to play a role in shaping the response to that dire situation. While challenges lie ahead for the Federal Reserve System, the state of crisis has passed, and I have decided not to continue my service into a new term.”
It is rather early to announce a 2016 departure but Mr Kocherlakota had made his decision. “I think once he had made up his mind and informed the board we thought it was good governance to announce it,” said Randall Hogan, chairman of the Minneapolis Fed board. Mr Hogan said the board is not launching an immediate search process, implying Mr Kocherlakota will indeed serve out his term, which runs until February 2016. Read more
CreditSights points out today that changes in gross ECB liquidity provided to the euro area’s banking sector closely track changes in 10 year Bund yields:
Could unexpectedly low levels of Treasury yields, pushed down by monetary policy in Europe and Japan, lead the Fed to raise interest rates earlier and faster than it otherwise would? That’s the prospect raised by an intriguing and important speech today by New York Fed president William Dudley. He makes dovish arguments about when rates should lift off, but forecasts they actually will rise by mid-2015, in line with consensus. He then breaks new ground by suggesting the pace of rate rises will depend on how financial markets respond to them.
(1) Dudley is dovish… Read more
If analyst comments in our inbox are anything to go by, the latest FOMC minutes, released on Wednesday, provided nothing much to write home about. Everything revealed was pretty much as expected.
One thing did prompt our eyebrows to raise, however. More on that below, but first here’s some of the reaction. Stephen Lewis at Monument Securities wrote:
The minutes of the FOMC meeting on 28-29 October sprang few surprises. Compared with earlier meetings, FOMC members gave more prominence to the risks stemming from worsening conditions elsewhere in the world but ‘many participants’ expected the impact of foreign developments on US growth to be limited.
Paul Krugman commented this week that despite all the talk about imminent rates raises, the Fed doesn’t actually have much reason to raise rates just yet.
Or as he put it:
And as usual, I wonder why anyone is talking about this at all. Yes, unemployment has fallen. But there is huge ambiguity about what level of unemployment is sustainable given changing demography, the uncertain degree to which people might return to the work force given better job availability, and so on.
Though, none of that has stopped the Fed from slyly tinkering with the rates it offers on its still experimental Term-Deposit Facility. Read more
With the end of QE, just a quick chart to reiterate that central bank bond buying doesn’t work the way one might expect.
Far from reducing bond yields, when the Federal Reserve buys bonds, it tends to make yields go up. Equally, when it stops – or says it will stop, or tapers – the yield goes down. Read more
The Fed’s balance sheet is no longer in expansion mode, which means it’s time for post-mortems of the most recent asset purchase programme. (Our colleague John Authers has a very good round-up of what did and didn’t happen since QE3 began.)
We want to focus on the fact that the most recent round of bond-buying seemed to have no inflationary impact. If anything, an observer of the data who had no preconceptions about monetary policy operations would conclude that QE3 was disinflationary. Alphaville writers have been exploring this possibility for years (though without firm conclusions).
Let’s start by looking at the changes in actual inflation since the start of 2010. Read more
(The chart frames the upper and lower forecasts of the central tendency, which removes the highest three and lowest three forecasts of the FOMC as a whole. The red line is the midpoint between the two.)
Starting in 2009, the midpoint of the central tendency projections for the long-run unemployment rate climbed from 4.9 per cent to 5.6 per cent during the next three years. Read more
A funny thing has happened since the Federal Reserve announced it would begin cutting back on its bond-buying on December 18, 2013: the yield curve has flattened like a pancake.
A new paper by several Harvard economists, including former Treasury Secretary Larry Summers, argues that a little more than a third of the impact of the Fed’s asset purchase programmes was “offset” by the Treasury’s decision to lengthen the maturity of its outstanding bonds:
Most people know that China’s currency is classified according to trading conditions. There is, for example, CNY, which refers to onshore yuan. There’s CNH, which refers to Hong Kong (offshore) yuan. And then there’s NDF, the non-deliverable forward market.
What differentiates these currencies are the terms and conditions that apply to those particular market zones, and how easy or not it is to transfer currency in and out. As implied yields of the respective markets show (chart via BNP Paribas), the rates of return for all of these markets varies significantly — because they are, to some extent, entirely different currencies:
The Federal Reserve’s latest flow of funds data shows that US households have rediscovered their credit cards, and lenders are eager to oblige them. Just look at this:
Since I wrote about the Fed debate ten days ago, the market consensus has moved rapidly towards a change in the Fed’s “considerable time” language this Wednesday. I was cautious about the timing, however, because this is not straightforward – coming up with new language is quite a challenge.
This is a (very long) attempt to think through the Fed’s options. The bottom line is that “considerable time” may survive in some form on Wednesday, but if so, I’ll be surprised if there is not a significant change to the statement that sets up its eventual departure. Read more