personal views of a former fed trader

Tag: ON RRP

The Elasticity of 5 Basis Points

Large money market investors will move billions for even a basis point. A 5bps increase to the RRP offering rate led to a $200b+ surge in participation, but there is a wrinkle to the story. The bulk of the increase likely came from Government Sponsored Enterprises (“GSEs”) who were leaving hundreds of billions at 0% in their Fed account, so it was not an incremental flow from the private sector. That being said, the 5bps increase puts money market funds (“MMFs”) in a position to offer their investors a few basis points in yield. This will make it easier for banks to continue to push out their high cost deposits. The departed deposits will quickly be replaced by the constant flow of low cost deposits created from Fed financed deficit spending. In this post we shed light behind this week’s RRP surge, the improving funding profiles of banks, and why this means FRA-OIS will continue to narrow.

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ON RRP Take-Up Will Go Much Higher

The humble ON RRP is in the spotlight as take-up marches steadily upwards. It will go much, much higher. Increasing participation is largely a function of two structural forces in the financial system: on-going Fed QE ($120b/month) and Basel III constraints. On the margins, changes in the level of the TGA have some impact as well. Water pouring into a glass remains in the glass, until the glass is full and then every incremental drop overflows. The Fed has been adding tremendous amounts of liquidity into the financial system over the past year, and there was initially very little take-up in the ON RRP. But now it appears the banking system is full – Basel III constraints are becoming binding. The incremental QE deposits are flowing out of banks and into MMFs, and then down the ON RRP drain. The system is working as intended. In this post we review the cause of increasing ON RRP take-up, note that high take-up will be a permanent feature going forward, and suggest that money market rates will fall below the ON RRP offering rate.

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The ON RRP Will Never Be A Floor

The Fed would like the ON RRP to play a bigger role in its rate control framework, but the ON RRP has been and will always be a very leaky floor for money market rates. From 2016 to early 2018, Treasury bills and agency discount notes consistently traded several basis points below the ON RRP. Today, even tri-party GC repo is occasionally dipping below the floor. The floor will only get leakier as money floods into the front end: QE continues to pour $120b a month into the banking system, the TGA continues to decline, and banks continue to shed low quality deposits. In this post we review how the ON RRP transmits policy rates, why the global nature of the dollar system means it will always be a leaky floor, and why even a ON RRP rate adjustment may not protect the 0 percent lower bound.

The ON RRP has been a very leaky floor for money markets
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