Fed day
Sept 18, 2019
See the man with the stage fright
Just standin’ up there to give it all his might
And he got caught in the spotlight
But when we get to the end
He wants to start all over again -The Band
–The repo surge of the last couple of days has brightened the spotlight on today’s FOMC meeting and announcement. A cut of 25 bps is expected. Because of the turmoil in money markets it’s likely forward guidance will be more dovish than otherwise. Another tweak in IOER is likely. The first priority is to make sure the system has liquidity. Monday’s Fed effective rate (EFFR) was 2.25% as compared to an average of exactly 2.13% for the first 15 days of September. Yesterday’s o/n repo was reportedly over 7% early yesterday morning, before the Fed stepped in with its first repo operation in many years. The NY Fed subsequently announced another $75b repo for this morning, but yesterday’s Fed eff is likely to be above 225 bps. Sept FF (FFU9) settled -1.5 yesterday at 97.925 or 2.075%. Using perhaps dubious assumptions, I calculate final settle of 97.86 on no ease or 97.96 with today’s expected ease.
–It’s clear that given the amount of treasuries and agencies in existence, we’re no longer in an “ample reserves” regime. While the repo surge of the last couple of days caught markets and the Fed by surprise, it wasn’t completely un-anticipated that this time would come. Lorie Logan, SVP of the Fed’s NY desk gave a speech about this exact topic in April (excerpt below):
https://www.newyorkfed.org/newsevents/speeches/2019/log190417
At some point, [NOW!] the FOMC will decide that the system has reached a level of reserves consistent with efficient and effective implementation.
Once this determination has been made by the FOMC, the Desk will need to conduct outright purchases of Treasury securities to supply reserves in order to offset the general decline in reserves from trend growth in non-reserve liabilities and ensure that reserves remain ample.21 In this regard, these purchases will have the same purpose as they did prior to the financial crisis—expanding the size of the SOMA portfolio to accommodate growth in currency and other liabilities. However, the size of these purchases will likely be larger in nominal terms because the growth of non-reserve liabilities is larger.
–The point is, the Fed has NOT lost control of money markets, though the last two days have been a challenge. A more pernicious problem is lower liquidity in general. and it’s likely, in my opinion, to become a more persistent issue. Also, year end demand for funds may be much harder to gauge.
–Yesterday, the spread between EDZ9 and FFF0 fell 3.5 bps to 38.0, reversing a bit of the recent spike. It’s an indication that the Fed will get things back under control. Call spread buying across interest rate futures appeared to be prevalent, with the red pack settling +3.625 and greens +3.875. The five year note fell 3.9 to 1.663% and tens 3.5 bps to 1.808%. On a Fed cut, if the new Fed effective comes in at 187 to 188, it will still be higher than the ten year yield.
