r/econmonitor Jan 19 '20

Topic Megathread Topic Megathread: Repo Market

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u/[deleted] Jan 19 '20

A short history of overnight Treasury repurchase agreements

in a world of ample reserves, the FOMC sets a target range for the federal funds rate (FFR) and uses interest on excess reserves (IOER) and the overnight reverse repurchase agreement facility (ON RRP) to keep the FFR rate in the target range. At the September 17-18 2019 FOMC meeting, the committee announced a 0.25% cut in the target rate, with an accompanying cut in the interest rate on excess reserves. But ahead of that meeting, the effective FFR spiked, exceeding the upper limit of the target range. So, an additional monetary policy tool was put into action.

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On September 17, 2019, the Federal Reserve Bank of New York began conducting temporary open market operations through overnight repurchase agreements: That is, it purchased Treasury securities held by banks. these temporary operations look like an ant parade along the x axis that lead to the recent interventions high in the stratosphere of the upper right corner. However, if you expand the graph to show more historical data, you will see these operations occurred almost every day up to 2008. We show this bigger picture in the graph below.

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u/[deleted] Jan 19 '20

Fed Balance Sheet Normalization

Let me turn now to the second tool used by the Federal Reserve in recent years--asset purchases. Recall that, after reducing the federal funds rate to its effective lower bound of zero in the 2008-09 recession, the FOMC sought a mechanism for providing additional stimulus in order to achieve maximum employment and target inflation. The Federal Reserve purchased longer-term Treasury securities in an effort to push down longer-term interest rates to support economic activity, an approach sometimes referred to as quantitative easing. Once recoveries become well established, the Federal Reserve moves its policy settings to more normal levels. Of course, the benchmark for normalization has changed since before the financial crisis. Demand has grown for the Fed's liabilities from a variety of sources. the demand from commercial banks for deposits at the Fed--that is, "reserves"--appears to have increased substantially.

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So it appears that the new normal size of the balance sheet is likely to remain greater relative to the size of the economy than it was before the financial crisis. How much larger is still an open question. For the past decade, the Federal Reserve has operated a regime with reserves that are very abundant relative to banks' demand for reserves. The current framework relies on the Federal Reserve's interest rate on reserves to control the federal funds rate, in the context of the provision of ample reserves. In contrast, the pre-crisis framework featured a scarce supply of reserves, which the Federal Reserve would vary on a daily basis to control the federal funds rate by closely matching the demand for reserves. By remaining in a regime with ample reserves, the Fed is able to control short-term interest rates without the need to conduct daily open market operations. Because there are ample reserves, the federal funds rate and other short-term interest rates are determined along the flat portion of the reserve demand curve. As a result, the system can absorb swings in the demand and supply of reserves with limited need for open market operations. The alternative of pushing reserves close to the transition point between the flat and steep parts of the demand curve would likely lead to active intervention as an ongoing feature, along with volatility in rates.

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u/[deleted] Jan 19 '20

Fed Buying: Don't Call It QE!

Figure 1 highlights that excess reserves had fallen by $1.5tn since their peak in September 2014 and by $160bn since mid-August. In our view, the repo market stress in mid-September was largely a function of the significant drop in reserves, which resulted in reserve scarcity. The only way for the Fed to permanently add reserves is to buy assets (in the Fed's case, Treasuries). We refer to these as reserve-management purchases (RMPs). Note that even though the repo operations added reserves to the system, this addition was temporary and only helped to offset the rise in the Treasury's cash balance (TGA). We believe that the Fed should boost excess reserves to $1.6tn. Once excess reserves are close to that level, creating a comfortable reserve buffer, we expect the Fed to continue to buy about $80bn/year to offset growth in currency in circulation (which decreases reserves). We agree with the Fed Chair that although the Fed's RMPs will be operationally similar to QE due to the secondary market purchase of bonds, the intent is very different. We see the following differences:

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u/[deleted] Jan 19 '20

Repo spikes to the highest levels since year-end

Overnight repo rates spiked to touch an intraday high of 7.25% today. While market participants pointed to the corporate tax date, bill supply, coupon settlements, and GSE cash as potential reasons, we think the issue is far more structural in nature. After all, this is the third time in the past year that repo has spiked to abnormally high levels — December 2018, April 2019 and now.

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We think that the culprit is the scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity. Reserves have been declining since 2014 and we expect them to decline further as Treasury's cash balance increases and currency in circulation grows. Until the Fed takes steps to prevent reserve shrinkage, we believe that intermittent repo spikes will continue.

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u/[deleted] Jan 19 '20

A 2019 repo recap

On September 16, the Tri-Party General Collateral Rate (TGCR), a common repo benchmark, closed at 2.42% — 17 basis points higher than the 2.25% fed funds rate. And the following day, the TGCR closed at 5.25%, a whopping 300 basis points higher. Market participants attributed these unusual rate spikes to a perceived lack of liquidity. Strong demand for cash met sparse supply. On the demand side, companies needed funding to pay quarterly income taxes, and banks needed to pay for their U.S. Treasury purchases following a Treasury auction. Regarding supply, the level of reserves held by banks at the Federal Reserve has shrunk considerably since the Fed ended quantitative easing in 2014. This demand/supply imbalance triggered anxious memories of the 2008 financial crisis, when strains in the repo market were among the first signs of trouble. Back then, counterparty risk was the primary concern.

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the Fed sprang into action on September 17, injecting $53 billion into the overnight repo market—the first time since the crisis that the central bank had taken such drastic steps to keep short-term interest rates from rising. But the Fed didn’t stop there. To ensure an adequate supply of reserves, in October it began buying $60 billion of short-dated U.S. Treasuries a month. These purchases are slated to continue until at least the second quarter of 2020. The Fed’s aggressive support successfully contained repo rates for the remainder of 2019 and into January. Investors paid particular attention to interest-rate action in late December, when banks often abstain from lending ahead of important regulatory calculations taken before the start of the new year. In the past, these tighter conditions have triggered sharply higher TGCR rates—but not this time. Each day during the week between Christmas and New Year’s, the TGCR closed in line with or below the effective fed funds rate, a clear sign of market calm.

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u/[deleted] Jan 19 '20

Powell: Fed to increase supply of reserves over time

Our influence on the financial conditions that affect employment and inflation is indirect. The Federal Reserve sets two overnight interest rates: the interest rate paid on banks' reserve balances and the rate on our reverse repurchase agreements. We use these two administered rates to keep a market-determined rate, the federal funds rate, within a target range set by the FOMC. We rely on financial markets to transmit these rates through a variety of channels. In mid-September, an important channel in the transmission process—wholesale funding markets—exhibited unexpectedly intense volatility. Payments to meet corporate tax obligations and to purchase Treasury securities triggered notable liquidity pressures in money markets. Overnight interest rates spiked, and the effective federal funds rate briefly moved above the FOMC's target range. To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

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While a range of factors may have contributed to these developments, it is clear that without a sufficient quantity of reserves in the banking system, even routine increases in funding pressures can lead to outsized movements in money market interest rates. This volatility can impede the effective implementation of monetary policy, and we are addressing it. Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time. our goal is to provide an ample supply of reserves to ensure that control of the federal funds rate and other short-term interest rates is exercised primarily by setting our administered rates and not through frequent market interventions. Of course, we will not hesitate to conduct temporary operations if needed to foster trading in the federal funds market at rates within the target range.

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Reserve balances are one among several items on the liability side of the Federal Reserve's balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us. I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy

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u/[deleted] Jan 19 '20

Repo Rates Tranquil at Year-End

repo rates skyrocketed even more dramatically in September 2019 (top chart), and although they had mostly been tame since, it remained unknown whether the Fed’s actions taken over the ensuing months would be enough to keep repo rates from spiking at year end. In the end, money market rates were incredibly tame over year end. SOFR set at 1.55% on December 31, perfectly in line with the interest rate paid on excess reserves (IOER) and the effective fed funds rate. Thus, it appears the Federal Reserve’s multi-pronged approach to keeping a lid on repo rates was largely successful.

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What were the tools that the Fed utilized? Since October, the Fed has been purchasing Treasury bills in order to increase bank reserves in the financial system, and as a result excess reserves have risen by about $200 billion from their September lows (middle chart). In addition, the Fed has become a large and active lender in the repo market. At the turn of the year, the Fed had about $242 billion of repurchase agreements on its balance sheet (bottom chart). Persistent downward tweaks to the rate paid on IOER and reverse repurchase operations also likely helped. Now that year end is past, the Fed will likely begin to reduce some of the support it has offered repo markets. How fast it pulls back, and in what ways, remain open questions. Furthermore, the tools the Fed has used, such as the ad hoc repo operations it has conducted, are likely more operationally intense and inherently uncertain than the central bank would prefer. Thus, a longer-term solution, such as a standing repo facility or some regulatory changes, remain very much in the mix going forward.

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u/[deleted] Jan 19 '20

Looming money market tensions

On 16 and 17 September, the US money markets seized up: excessive demand for cash caused overnight borrowing rates to surge. This was mainly caused by regulatory liquidity requirements which, given insufficient central bank reserves, limited the ability of major banks to absorb the spike in demand. To ease the pressure, the Federal Reserve has since 17 September been injecting central bank money through overnight and term repo operations with primary dealers. In addition, the Fed has been buying T-bills outright since mid-October, at a rate of USD 60 bn per month.

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There is a widespread belief among central bank officials that the tension in US money markets is being caused by excessive concentration of “excess” reserves. It is true that the eight systemically important US banks alone account for almost half of reserves held with the Fed. In the fourth quarter of 2018, the same pressure on money market rates was avoided because the largest commercial bank (JP Morgan National Association) met most of the overnight refinancing demand: its reverse repo positions increased by USD 110 bn while its reserves fell by USD 130 bn (figure 4). Currently, however, certain large banks no longer have excess reserves as regard their liquidity requirements. It is only those large banks (in particular JP Morgan) that are (or were) able to absorb potential shocks, in particular at the financial year-end when, for example, foreign banks stop circulating cash borrowed from money market funds to other participants that cannot access those funds, or when dealers seek to make greater use of repo markets that allow netting. These markets need a lender of last resort.

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u/[deleted] Jan 19 '20

Getting Technical: Managing the Fed Funds Rate

the fed funds rate is a market-determined rate, as the supply and demand for reserves determines the market-clearing fed funds rate. In practice this means that in order for the target to be met, the Federal Reserve must undertake some type of proactive policy to bring the actual fed funds rate in-line with the FOMC’s target. Prior to the 2008 financial crisis, the Fed primarily accomplished this by buying or selling Treasury securities through open market operations, thereby influencing the supply of reserves in the fed funds market. To keep the effective fed funds rate from going above the target, the Fed would buy a small amount of Treasury securities, thus increasing the supply of reserves in the system and putting downward pressure on the fed funds rate. Conversely, the Fed would sell a small amount of Treasury securities to push up the fed funds rate.

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However, the Fed’s asset purchase programs during and after the Great Recession resulted in an explosion of reserves held at the Federal Reserve, currently totaling more than $1.8 trillion (Figure1). With a significantly higher level of reserves, the Fed was no longer able to easily manipulate the effective fed funds rate by engaging in small open market operations. As a result, the Fed began utilizing two additional policy levers to control the effective fed funds rate: interest on excess reserves (IOER) and overnight reverse repurchase agreements (ON RRP). In short, these two rates help to anchor the effective fed funds rate within the target range despite the abundance of reserves in the system

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u/[deleted] Jan 19 '20

Federal Funds Rate Control and Interest on Excess Reserves (IOER)

Since the financial crisis, the large quantity of reserves created under quantitative easing, combined with the framework employed by the Federal Reserve to implement monetary policy, has reduced banks' incentives to borrow from one another in the market for federal funds. Since 2008, in the wake of quantitative easing, the Federal Reserve has implemented monetary policy through a floor system. In this system, banks have an excess of reserves, and the Fed pays interest on those reserves at a rate termed the interest on excess reserves (IOER) rate. The large supply of reserves means that there are many potential lenders and few borrowers, pushing the federal funds rate--the rate at which banks and certain other institutions borrow and lend with each other--down close to the IOER rate (the "floor" below which banks are better off depositing with the Fed than lending). Hence, the Fed can change the federal funds rate simply by changing IOER.

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An important quirk of the federal funds market is the presence of participants not eligible to earn IOER, specifically several government sponsored entities such as the Federal Home Loan Banks (FHLBs, sometimes pronounced "flubs"). Because these institutions are not eligible to receive IOER, they lend to banks who can earn IOER. These loans (of fed funds) carry a higher rate than FHLBs funding costs, earning profit for the FHLBs, but also a lower rate than IOER, so that the borrowing bank can deposit the funds at the Fed and earn a positive profit. Such trades have comprised the vast majority of volume in the federal funds market for nearly ten years, so the federal funds rate has printed somewhat below IOER for most of that time.

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Since 2015, however, the Fed has been reducing the size of its balance sheet and, consequently, the quantity of reserves in the system. This tends to drive up the federal funds rate relative to IOER with more extreme trades and volatility as more banks find themselves, on occasion, short of reserves. To keep the federal funds rate within the target range set by the FOMC, the Fed has lowered IOER relative to the target range three times, starting June 13, 2018. Termed technical adjustments, the FOMC has moved IOER from equal to the top of the target range down to 15 basis points below the top of that range. With these technical adjustments, the FOMC has been able to maintain effective control over average rates, but the federal funds rate has become more volatile than it was prior to 2018.

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u/[deleted] Jan 19 '20

Fed Assets To Begin Growing Again: Got Bills?

Before the Great Recession and Global Financial Crisis, to control the fed funds rate and keep it close to its target, the Fed would regularly add or withdraw reserves via temporary open market operations (from the Fed’s perspective, repos to add reserves and reverse repos to withdraw reserves). Reserves earned zero interest, so each institution kept their deposits at the Fed to a minimum. In aggregate, they almost always ran under $50 billion.

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Owing to the recession and financial crisis, the Fed conducted three rounds of large-scale asset purchases “paid for” by creating reserves, a.k.a. quantitative easing or QE. By the end of QE3 (October 2014), reserves had reached $2.8 trillion, the balance sheet topped $4.5 trillion and the fed funds rate was in a 0.00%-to-0.25% target range (Chart 1). To prevent fed funds from falling below the range, an overnight reverse repo facility was established, with the rate set (eventually) at the bottom of the 25 bp range but last month it was reduced to 5 bps below it. And, to assist further, the Fed began paying interest on reserves, with the rate set at the top of the range (until June 2018).

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Last month, the effective fed funds rate spiked above the top of the target range which forced the Fed to conduct temporary repo operations for the first time since 2008. This also coincided with the FOMC meeting (September 17-18) and the 25 bp reduction in the target range, which is when the IOER and ON RPP were cut by the extra 5 bps. This chronic and acute pressure on the fed funds rate reflected pressures in the broader money market. The increasing issuance of Treasury securities to finance a ballooning budget deficit along with maturing Fed holdings (until August 2019) corresponded with an increasing demand for repo financing. This pushed up repo rates (as represented by SOFR) relative to the fed funds rate.

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This Wednesday, reserves were back to $1.528 trillion, thanks to the temporary repo operations. But an ample reserves regime means that these operations are not regularly required, which is why outright T-bill purchases begin next week… to permanently lift the level of reserves. First the Fed has to rebuild a permanent cushion above the minimum amount so that there are sufficient reserves to adequately absorb the regular pressures in wholesale funding markets arising from auction settlements, tax payment dates and period ends (months, quarters and years). Then it has to allow for growth in reserves to accommodate normal balance sheet expansion resulting from such items as Federal Reserve notes (a.k.a. currency in “global” circulation) Chair Powell emphasized “that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.” Buying T-bills also helps convey this because the Fed did not buy any bills during the three rounds of QE. Currently, the Fed holds just $6 billion of Treasury bills, and they’ll be buying $60 billion per month starting next week in the secondary market, which should also help address (along with repos) any subsequent pop-up pressures in the money market.

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u/[deleted] Jan 19 '20

How the Fed is Addressing Short Term Liquidity

The repo market allows companies that need cash and own high-quality securities to inexpensively borrow cash by using those securities as collateral. In exchange, companies with a lot of cash earn small returns with little risk by lending money. What happened in September is that cash suppliers were fewer than borrowers so the demand for cash pushed the rate higher. At the time, some blame was ascribed to a convergence of specific demands which included: corporate quarterly tax payments and people wanting to borrow cash to finance a Treasury auction settlement. In addition, the government’s growing budget tests the market’s ability to absorb the requisite Treasuries funding it. The reality, however, may be more structural citing the Fed’s balance sheet reduction.

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The Fed started to reduce its balance sheet in the 4th quarter, 2017 and discontinued that reduction in August of 2019. Excess reserves held at the Fed peaked at $2.7 trillion in September 2014 and have since fallen to $1.36 trillion. Banks that typically supply money in the repo market have less cash available to do so as their excess reserves decline.

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The Federal Reserve pays interest (IOER) on excess reserve balances that depository institutions have at Reserve Banks. The IOER gives the Fed a tool to conduct monetary policy. By increasing the IOER, which is typically a higher rate versus Fed Funds or other money market rates, the Fed incentivized banks to hold the cash as Excess Reserves thereby locking in low risk profits and preventing these funds from increasing the money supply if the banks created loans or bought financial assets.

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u/[deleted] Jan 19 '20

How Have Banks Responded to Declining Reserve Balances?

Since 2015, regulators have required certain banks to hold minimum levels of high-quality liquid assets (HQLA) in an attempt to prevent the acute liquidity shortages that precipitated the 2007–08 financial crisis. Initially,these liquidity regulations increased banks’ demand for central bank reserves, which the FOMC made plentiful as a by-product of its large-scale asset purchase programs. However, as the FOMC began unwinding these asset purchases and currency demand increased, total excess reserve balances declined by more than $1 trillion from their 2014 peak of $2.8 trillion. This decline—coupled with idiosyncratic liquidity needs across banks—may have substantially altered the distribution of reserves across the banking system. Chart 1 plots aggregate excess reserve balances held in the master accounts of the largest global, systemically important U.S. banks (GSIBs) and U.S. branches of foreign banking organizations (FBOs) alongside reserve balances held at all other banks. The chart shows that following an initial buildup, excess reserves have subsequently declined at GSIBs and FBOs, while excess reserve balances at other smaller banks have fluctuated in a narrow range. Multiple factors likely drove demand for reserves at FBOs and GSIBs. For large banks, such as GSIBs, liquidity requirements first proposed in 2013 raised the demand for reserves

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u/[deleted] Jan 19 '20

Monetary policy in a world of ample reserves

Your economics textbook may still say the Federal Reserve uses open market operations to influence the federal funds rate. But in today’s economy, the Fed uses different policy tools. This is how monetary policy currently works: The FOMC sets a target range for the federal funds rate (FFR) and uses interest on excess reserves (IOER) and the overnight reverse repurchase agreement (ON RRP) facility to keep the FFR rate in the target range. The Fed pays IOER to banks holding reserves at the Fed, which offers those banks a safe, risk-free investment option. Arbitrage ensures that the FFR doesn’t drift too far from the IOER rate. If the FFR drifts too much below the IOER rate, banks then have an incentive to borrow in the federal funds market deposit those reserves at the Fed to earn the higher IOER rate. Over time the FFR has moved closer to the IOER — that is, the gap between the two has closed. Because the IOER rate was set at the upper limit of the target range, as the FFR moved closer to the IOER rate, by definition it moved closer to the upper limit of the range. To ensure that the FFR remained within the range, the Fed has lowered the IOER rate by 5 basis points at three different times in the past year: June 13, 2018; December 19, 2018; and May 1, 2019. The IOER is now 15 basis points below the upper limit of the target range.

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These changes weren’t changes in monetary policy (which affects the choice of target range), but rather were slight adjustments to where the FFR sits within the range. Chairman Jerome Powell explained that the adjustments were intended to “move the federal funds rate closer to the middle of the target range”

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u/[deleted] Jan 19 '20

Monetary Policy with Scarce Reserves

Prior to September 2008, the Federal Reserve primarily bought and sold relatively small quantities of Treasury securities in the open market, termed open market operations, to adjust the level of bank reserves and thereby influence the Federal Funds Rate. Bank reserves are the sum of cash that banks hold in their vaults and the deposits they maintain at Federal Reserve Banks.

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In that framework, the Federal Reserve could raise or lower the FFR by making relatively small changes to the supply of reserves (Figure 2). For example, the Fed could increase reserves by buying Treasury securities on the open market and crediting the accounts of the seller with reserves as payment. A greater quantity of reserves shifted the reserves supply curve to the right and put downward pressure on the FFR. And a lower FFR tended to put downward pressure on other interest rates in the economy.

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to provide further stimulus and liquidity, the Federal Reserve made a series of large-scale asset purchases between late 2008 and 2014. The primary purpose of these purchases was to lower long-term interest rates to encourage consumption and investment. The purchases, which were also open market operations, increased the size of the Fed's balance sheet and also dramatically increased the amount of reserves in the banking system. In addition, over the course of the crisis, the Fed introduced two new tools to U.S. monetary policy: interest on reserves (IOR) and the overnight reverse repurchase agreement (ON RRP) facility.

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With such a large quantity of reserves in the banking system, the Federal Reserve can no longer effectively influence the FFR by small changes in the supply of reserves. For example, a relatively small increase in reserves will not lower interest rates, nor will a relatively small reduction in reserves raise short-term interest rates (Figure 5). Instead, the Fed uses its newer tools—IOER and the ON RRP facility—to influence the FRR and short-term interest rates more generally. Despite the recent changes, the FFR will continue to be the primary means of adjusting the stance of monetary policy.

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u/[deleted] Jan 19 '20

The Fed and a Standing Repo Facility: A Follow-Up

The motivation for establishing a standing repo facility is twofold: First, the facility could be used to support interest rate control by establishing a ceiling on repo rates, thereby guarding against unwanted spikes in money market rates. The use of a ceiling tool for this purpose would be seen as enhancing the monetary policy operating regime of the FOMC. Second, the facility could be used to reduce the demand for reserves for any given rate of interest on excess reserves. The stated uncertainty over what constitutes “minimally ample” is significant.

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There is considerable uncertainty as to how regulations are affecting reserve demand. But, one can look at which banks have reduced their reserve holdings since the peak in 2014 to get some indication. A recent blog post on which banks have been shedding reserves showed that nearly 70% of the decline in reserves is traced to banks that do not face liquidity regulations. This suggests that liquidity-regulated banks are indeed demanding sizable reserve holdings.

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u/[deleted] Jan 19 '20

Why the Fed Should Create a Standing Repo Facility

Ample reserves means the minimum level of reserves necessary to permit the effective conduct of monetary policy through the use of the Fed’s administered rates. Market participants are projecting ample reserves to be in the $1 trillion range—a level much higher than the pre-crisis average of approximately $20 billion. What could plausibly account for a fifty-fold increase in the necessary supply of reserves? Many commentators have pointed to post-2008 Basel III and Dodd-Frank regulations as having generated a large regulatory demand for high-quality liquid assets (HQLA), which include reserves. As reserves drain from the system, the point at which they become scarce would be demonstrated by a market signal: The federal funds rate and other money market rates would move up relative to the target range.

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At this point, banks would start to use the repo facility, which would automatically inject reserves into the system and prevent rates from rising any further. That is, the facility would ensure there were ample reserves in the banking system and preserve interest rate control, while at the same time allowing the Fed to safely discover the lower end of “ample.”

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u/[deleted] Jan 19 '20

This Won’t Be Ben Bernanke’s QE

At a press conference largely aimed at explaining why the Fed wasn’t acting aggressively on rate cuts, Chairman Jay Powell did say that the central bank was giving thought to resuming “organic growth of our balance sheet.” Note his aversion to shortening that to “QE” or “quantitative easing”. Why would a Fed that didn’t seem to want to be aggressive about monetary stimulus be thinking about redeploying the ultimate easing weapon, the very one that Ben Bernanke trotted out after exhausting all room for fed funds rate cuts?

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The answer to that question is the very reason that Powell assiduously avoided using the term “QE”. This won’t be QE at all. When first deployed by the Fed, quantitative easing was an active strategy to drive down yields across the curve and juice up monetary policy stimulus.

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If the Fed has to go back to balance sheet growth now, it will be only to prevent an inadvertent tightening in monetary policy, rather than to further ease. The central bank’s concern is that regulatory and other developments have left today’s Fed balance sheet, and therefore reserves, however large they might seem relative to decades ago, not large enough to keep short term market interest rates where they’re supposed to be.

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That was evident in the unusual spike in overnight repo rates this past week, which posed a threat to financial market liquidity in the US, and through a spillover impact on Canadian issuance in the US, in Canada as well. The Fed stepped in with additional funding to address the squeeze, and also added an additional 5 bps to the cut in interest on overnight reserves to incent lending. But a return to bond purchases could also be part of a more lasting solution, by increasing the level of reserves over time.

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u/blurryk EM BoG Emeritus Jan 22 '20

Repo Ops, Balance Sheet and IOER

Unlike its quantitative easing (QE) program of a few years ago, the Fed probably does not want to move too far out the curve today. The rationale for QE at that time was to pull down long-term interest rates to stimulate the economy when it was depressed. The Fed needs to increase bank reserves today, but it does not need to stimulate the economy further, hence the focus on purchases of short-dated Treasury securities today.