re: I think its time we talk about the next Fed policy tool (9/17 Update - Neutered)

Dudley Speech 5/20/14. He speaks to Reverse Repo toward the end. Maybe the Fed doesn't set up full allotment?

quote:

---

Enhancing confidence in the Fed’s ability to control money market rates, and hence, inflation, might also help keep inflation expectations well anchored.

---

quote:

---

Two issues with the overnight reverse repo rate warrant careful consideration. The first is how big a footprint the facility should have in terms of volume. To the extent that the overnight RRP rate were set very close or equal to the interest rate on excess reserves (IOER) without caps, then this might result in a large amount of disintermediation out of banks through money market funds and other financial intermediaries into the facility. This could encourage further development of the shadow banking system. If this were deemed undesirable, this would argue for a wider spread between the overnight RRP and the IOER in order to reduce the volume of flows into the facility.

---

Dudley Full Speech

At any rate, Dudley keeps mentioning lift off of the economy. According to my husband's nightly rant, this is the most challenging business environment in his 40 year career. He thinks that if we are not already in recession, we are close.
At best, treading water, not lift off.

Not being a trader, I have to tune it out and stand pat as long as the FED is still engaged.

Damn, your February write-up points are made almost word for word in the June 17-18 minutes. to you sir.

"It was generally agreed that an ON RRP facility with an interest rate set below the IOER rate could play a useful supporting role to firm the floor under money market interest rates."

Here ya go Bennie. FED sunshine meeting notice for today.

quote:

---

Advanced Notice of a Meeting under Expedited Procedures It is anticipated that the closed meeting of the Board of Governors of the Federal Reserve System at 11:30 AM on Monday, July 14, 2014, will be held under expedited procedures, as set forth in section 26lb.7 of the Board's Rules Regarding Public Observation of Meetings, at the Board's offices at 20th Street and C Streets, N.W., Washington, D.C. The following items of official Board business are tentatively scheduled to be considered at that meeting. Meeting Date: Monday, July 14, 2014

---

AND MATTERS CONSIDERED:

quote:

---

Review and determination by the Board of Governors of the advance and discount rates to be charged by the Federal Reserve Banks.

---

FRB

dp

Sorry just got around to this (forgot for a little bit)

So these minutes were pretty huge regarding the FRFA facility. They gave a lot of clarity into what they're thinking regarding a cap on the allotment amount or counterparties, as well as specifying the gap between IOER and the RRF rate, which was wider than what the market expected.

So why is the gap between IOER and the RRF rate important?
This one is fairly simple. Money market fund yields are determined simply by their returns and the yields on what they hold. Bank deposit rates are set by the bank, hence are usually slower to rise compared to say a 2a-7 fund SEC yield. If a depositer can earn more in a money market fund compared to a commercial bank deposit, this could cause a massive outflow from the banking system into the "shadow" banking system, something the Fed seriously wants to avoid. The market was expecting anywhere from 10-15bps, but the Fed was very conservative and set the preliminary range target at 20bps. There is also the issue of the Fed Funds market which is an entirely different issue (which they actually noted in the minutes regarding changing the calculation, however this is a very different topic and thread).

What did they say about counterparties or allotment caps and why is it important?
This is a big deal and a little more complicated. The Fed wants to avoid a situation that in a left tail event (crisis), everybody starts flocking to put all of their cash in funds that can face the FRFA facility. This would actually exacerbate a sell-off in risk assets and cause the normal market to quit functioning. Not only because everyone piles in for safety, but also because many credit investors buy based on spread. When you have bouts of risk off, risky assets sell-off and safe assets rally, widening spreads. In this situation since safe assets would be floored by the FRFA rate, it would require risky assets to sell-off even more to become attractive enough to buy.

So how do they avoid this. They're weighing either restricting the counterparty list or capping the allotment. I don't think restricting the counterparty list and allowing full allotment solves this at all, in fact it exacerbates it because you name your winners and losers right off the bat. I think it makes more sense to cap the allotment limit and expand counterparties and that is the feel I got from the minutes as well. Some of the members you could pick up right off the bat, for example the member that thought they could handle the exit strategy without the facility was 100% Lacker so you can take that with a grain of salt.

Take-aways
My initial thought about the Fed's interpretation of the facility a while ago was that they may not fully grasp how powerful of a tool they had. After these minutes, I believe they are a little worried how powerful of a tool this could be and want to make sure it doesn't roil markets. So far the facility has absolutely been effective in flooring market rates, outside of very late day trades you won't see GC repo trading below 5bps. Bills will trade below for various collateral reasons but those are sheer technical forces. Some repo traders even thought that we may have seen negative rates in May before we had a big amount of supply hit the market. It's going to be interesting how they communicate the timing of the first rate hike versus raising IOER/RRF rate, I thought they would do the former prior to a rate hike and I still feel that way but with less conviction than before.

A seperate but related issue is 2a-7 fund reform, it was believed that the move to a floating NAV was dead in water just a few short weeks ago but now it looks like the SEC may be having a vote on this soon. If they move to a floating NAV you'll likely see a lot of corporate treasurers pull assets as many held 2a-7 funds for the sheer accounting simplicity (or they just move to government only 2a-7 funds if they only vote on prime funds). We'll have to see how the pieces fall first but this will likely affect how the Fed approaches the counterparty and allotment issue for the facility.

Understood.

All motions passed:

- Prime funds to floating NAV
- Removed credit rating references and some issuer diversification requirements

The big one is floating NAV. I'll come back later with implications because this is a big vote.

The Fed now officially neutered the facility

Although the Fed increased single counterparty limits from $10B to $30B, it doesn't matter as the overall size of each operation is capped at $300B. For some context, the most a money market fund has ever used the facility for is 9.25B, and the only time the facility has ever had over 300B in use was this past quarter end (6/30) at $344B. However, that's all it will ever be. The Fed has essentially figured out how powerful (aka market dependent) this facility could be and decided that the risk of it furthering a systematic shock was too large of a risk.

In her testimony, Yellen commented that the facility will only be used long enough to help manage the rise in short-term interest rates before being phased out. Although things could absolutely change over time given changes in the market environment, it looks like the FRFA RRP will be laid to rest in a couple years (likely to be resurrected at the end of the next easing cycle).

quote:

---

Effective Monday, September 22, 2014, each eligible counterparty will be limited to one bid of up to $30 billion per day, an increase from the current $10 billion per-counterparty maximum bid limit, and each operation will be subject to an overall size limit of $300 billion. Each submitted request must include a rate of interest, subject to a specified maximum, which would apply only in the event that the total amount of offers received by the New York Fed exceeds the overall size limit of the operation. If the sum of the bids received is less than or equal to the overall size limit, awards will be made at the specified offering rate to all submitters. If the sum of the bids received is greater than the overall size limit, awards will be allocated using a single-price auction based on the “stopout” rate at which the overall size limit is reached, with all bids below this rate awarded in full at the stopout rate and all bids at this rate awarded on a pro rata basis at the stopout rate. The stopout rate will be determined by evaluating all bids in ascending order by submitted rate up to the point at which the total quantity of offers equals the overall size limit. The offering rate will be set at 0.05 percent (five basis points).

---

Now this is very interesting Benny. 8:30 am close time on last day of quarter. Largest amount evah! $407 billion bidded, $300 billion accepted. 102 Bids, 81 accepted. Look at spread of high low.

LINK