Fed Commits To Repos Through April, Keeps Main Rate On Hold, Raises IOER

The Fed kept rates on hold at their January meeting, as expected.

For the second straight pow wow, the decision was unanimous.

The composition of the voters has changed, but that wouldn’t have mattered. There was virtually no argument for moving either way at this meeting, and recent Fedspeak has centered almost exclusively on balance sheet policy, short-term funding markets and inflation, not on any imminent change to the “good place” characterization of rates.

(Deutsche Bank)

In December, the dots showed policy on hold through 2020. Geopolitical tensions in the Mideast and pandemic fears aside, nothing has changed since last month that would prompt an urgent rethink or, in the Fed’s language, a “material reassessment”.

The statement describes growth as moderate and business spending as remaining “weak”. The latter continues to be a source of concern. Even as the US consumer is clearly healthy (and in good spirits) the same uncertainty that prompted the Fed to cut rates three times in 2019 continues to weigh on C-suite confidence.

On inflation, the January statement characterizes price pressures as subdued. Powell has made it abundantly clear that it would take a serious (and sustained) upside spike to put rate hikes back on the table. The Fed is, of course, in the process of a broad strategic rethink, centered around what (if anything) needs to change in order to help bring inflation sustainably to target. The ECB is conducing its own, similar review.

IOER was raised 5bp on Wednesday. January’s tweak marks the first time the Fed has moved to widen the spread between IOER and the bottom of the range. Fed funds fell below IOER for the first time since 2018 earlier this month. It’s a technical move, but it has big ramifications for some folks. Consider the following from Bloomberg’s Edward Bolingbroke:

A key question that traders are asking is what will happen to the Feb 20 fed funds contract with, or without, a tweak to the interest on excess reserves at today’s FOMC meeting. Volume in the contract is around 150,000 today — the second highest on record — helped by a flurry of early sales including a 20,000 block trade and a further 30,000 given in the screens at a price of 98.42. At that level, the implied yield is 1.58%. IOER is currently 1.55%, a five bps hike (currently around 60% priced in) would therefore imply a rate of 1.60%. That’s a potential two bps profit. The amount at stake for some front-end traders for what seems like just a minor adjustment is certainly not insignificant. So traders will be keeping a close eye on today’s IOER announcement. 

On repos, the Fed will continue to conduct operations at least through April (see the implementation note below). The rate on the O/N facility was raised by 5 basis points.

Needless to say, there are still questions around how repos will be tapered and the existing stock “absorbed” (if you will) by T-bill purchases. Bill Dudley on Wednesday told Bloomberg Radio that he thinks a standing repo facility is in the cards eventually. “I think that’s coming, but they have not made a decision yet”, he remarked, adding that the bill purchases “will take care of the big spike in repo rates [but] the next question is are they going to go a little bit further”.

The bill buying is itself a source of intense debate. It’s now assumed that a transition to short-coupon purchases is a matter a “when” not “if”, given expected negative net bill supply and liquidity concerns. That transition will present a communications challenge. The Fed is already struggling to differentiate between bill purchases for reserve management and QE “proper”. Buying anything other than bills will make that distinction even more blurry.

 

BMO’s Jon Hill and Ben Jeffery said last week that the Fed could go ahead and tip the change next month or in March. Privately available bill supply in Q2 will be -$321 billion “which would be the largest quarterly drop on record”, they note, adding the following: “The path of least resistance is for the Fed to alter its purchase schedule at the February or March operational announcements to reduce the risk of unnecessary liquidity deterioration [in the T-bill market]”.

The December minutes showed the Fed is intently focused on all of this, which is good, because there were no shortage of front-end strategists who spent the better part of Q3 and Q4 insisting Powell was asleep at the wheel.

The Chair will doubtlessly be quizzed in the press conference about the technicalities as well as whether the Fed’s liquidity injections have played a role in driving up equity prices since September. Correlation isn’t causation but… well, see the bottom pane in the visual below.

Powell will also be expected to pretend he’s a virologist on the way to giving his opinion on the Wuhan outbreak. And that’s fine. After all, his job entails pretending to be an economist, so why not a virologist too?

Meanwhile, Donald Trump continues to pound the table on the desirability (indeed, the necessity) of more rate cuts. He mentioned the Fed in multiple interviews from Davos, and went so far as to malign Powell during his formal address in Switzerland.

While the bar for additional cuts may well be much lower than the bar for hikes, the Fed is acutely aware of the extent to which Trump’s incessant badgering will make lawmakers sensitive to any accommodation delivered in 2020 above and beyond what can be clearly justified by the incoming data.

The irony is always the same: Trump has made it harder on himself by publicly deriding Powell. Now, any attempts to coerce the Fed chair in 2020 will be scrutinized relentlessly, even as Americans have become largely numb to the president’s weekly exhortations to monetary policy easing.

Full statement

Information received since the Federal Open Market Committee met in December indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending has been rising at a moderate pace, business fixed investment and exports remain weak. On a 12‑month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee decided to maintain the target range for the federal funds rate at 1‑1/2 to 1-3/4 percent. The Committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to the Committee’s symmetric 2 percent objective. The Committee will continue to monitor the implications of incoming information for the economic outlook, including global developments and muted inflation pressures, as it assesses the appropriate path of the target range for the federal funds rate.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

Implementation note

The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on January 29, 2020:

• The Board of Governors of the Federal Reserve System voted unanimously to set the interest rate paid on required and excess reserve balances at 1.60 percent, effective January 30, 2020. Setting the interest rate paid on required and excess reserve balances 10 basis points above the bottom of the target range for the federal funds rate is intended to foster trading in the federal funds market at rates well within the FOMC’s target range.
• As part of its policy decision, the Federal Open Market Committee voted to authorize and direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:”Effective January 30, 2020, the Federal Open Market Committee directs the Desk to undertake open market operations as necessary to maintain the federal funds rate in a target range of 1-1/2 to 1-3/4 percent. In light of recent and expected increases in the Federal Reserve’s non-reserve liabilities, the Committee directs the Desk to continue purchasing Treasury bills at least into the second quarter of 2020 to maintain over time ample reserve balances at or above the level that prevailed in early September 2019. The Committee also directs the Desk to continue conducting term and overnight repurchase agreement operations at least through April 2020 to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation. In addition, the Committee directs the Desk to conduct overnight reverse repurchase operations (and reverse repurchase operations with maturities of more than one day when necessary to accommodate weekend, holiday, or similar trading conventions) at an offering rate of 1.50 percent, in amounts limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations and by a per-counterparty limit of $30 billion per day.The Committee directs the Desk to continue rolling over at auction all principal payments from the Federal Reserve’s holdings of Treasury securities and to continue reinvesting all principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month. Principal payments from agency debt and agency mortgage-backed securities up to $20 billion per month will continue to be reinvested in Treasury securities to roughly match the maturity composition of Treasury securities outstanding; principal payments in excess of $20 billion per month will continue to be reinvested in agency mortgage-backed securities. Small deviations from these amounts for operational reasons are acceptable.The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions.”
• In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 2.25 percent.

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