Monetary Policy And Impact On Assets

Monetary Policy and Impact on Assets
The last note briefly addressed the benefits associated with the reverse repurchase facility (RRF). Indeed liabilities have increasingly moved from bank balance sheets to the Fed, freeing lending capacity. One must recall reserves are not fungible outside of the banking system (but can act as collateral for margin). With flow decreasing, the opportunity for small relative volume bids spread over a large quantity of transactions (most instances per unit time) decreased with market prices in many asset markets. Is more downside coming?
A cost of QE is high quality debt remains siloed. As previously described, the RRF allows for assets previously purchased by the Fed to serve the market only in a limited capacity. While they are not able to the reused as collateral, they do replace a portion of the demand for high quality assets in the market, leaving relatively more available for reuse. At present, the 5bps paid by the Fed essentially attempts to put a floor under the short-term price for money. The Fed established an overall cap in September, supposedly because MMFs would view the Fed as a more secure counterparty than banks. I take a different view: They Fed is balancing net income from securities lent with the monetary policy goal of keeping rates up. As Stone & McCarthy recently pointed out, demand exceeded the $300 billion cap, limiting the amount paid-out by the Fed at the 5bps rate, with excess bid via Dutch auction. In the recent auction coinciding with quarter-end the low bid hit a price of -20bps (the counterparty receives less than deposited in order to rent the high quality assets from the Fed). While one may count the result as a limited success in controlling the lower bound of short-term interest rates, the Fed controls the cap for the 5bps rate. Interest on reserves (IOR), at 25bps, holds the entire system afloat, where otherwise extreme supply (especially relative to demand) would dictate a lower price; In economic depression even more so. To improve the optics of control, causality is reversed when speaking of the price of money. The interbank interest rate for reserves is set by market forces, and daily, the central bank adjusts reserves to match. Mechanically the Fed’s ‘target’ is just that, and nothing more. Alternatively, with IOR and the RRF, the prices at the each extremis of the corridor are fiat, and impact the Fed balance sheet.

This post was published at Zero Hedge on 10/11/2014.