A month ago, I called readers’ attention to what I dubbed the “free money Fed arb.”
The mechanics are (or were) simple enough: Thanks to escalating bets on rate cuts in 2024, the rate banks were charged to access the backstop facility established in the wake of SVB’s collapse was considerably lower than the rate banks could earn from the Fed on their reserves.
The spread between the two was free money, and as such, it was no surprise to see borrowing from the Bank Term Funding Program balloon as the Fed’s dovish pivot prompted traders to price in more easing.
The high (i.e., the widest spread) was 64bps on January 16. As the figure above shows, it collapsed on Thursday, after the Fed slammed the door.
While announcing on Wednesday evening that no new loans would be made under the program from March 11, the Fed said the rate on new BTFP loans between now and then would be “no lower than the interest rate on reserve balances in effect on the day the loan is made.” In other words: No more free money.
On Thursday evening, the latest update showed facility usage was $167.77 billion, up from last week. You can expect the trajectory of these loans to moderate significantly now.
Discount window usage, meanwhile, rose to the highest since November 1, although at $2.785 billion, it’s still barely visible when plotted with BTFP. Regulators may compel banks to tap the discount window periodically going forward (whether they need liquidity or not) in a bid to remove the stigma, reports suggest.
The BTFP arbitrage opportunity was beginning to garner unwanted publicity. The Economist, for example, ran an article about it last week called, “How America accidentally made a free-money machine for banks.” (You heard it here first, folks.) “Bagehot weeps. The Fed should switch it off,” the piece advised.
And so they did. The Fed switched it off. The BTFP rate on Thursday was 5.4%, the same as the rate on reserves. No more free money. Or at least not down this particular avenue.
“accidentally”
Yes, “accidentally” for more than two whole months, with nary an action by the Fed (tho the spread technically loosened financial conditions at cross-purposes with its tempering rhetoric at the time). That is, until the media started reporting on it (after the analysts and blog authors worth paying for had already noted it, of course).
To quote The Economist article “…And because the Fed is owned by taxpayers, the free money the banks are hoovering up comes at the taxpayers’ expense.”
From their actions it seems like the Fed is owned by the banks….. OH wait IT IS!
The Economist need to do their fact checks.
The Economist is just wrong on that, though. No humor necessary. The Fed isn’t loaning out “taxpayers'” money. That’s just factually inaccurate.