S&P published a release entitled, "New U.S. Treasury Floating-Rate Notes Are Consistent With Our Principal Stability Fund Ratings Criteria" yesterday. It says, "Standard & Poor's Ratings Services today said that the new U.S. Treasury floating-rate notes (FRN) are consistent with our principal stability fund ratings criteria and, as such, would not be classified as a higher-risk investment. On Nov. 6, 2013, the U.S. Treasury announced final details of its initial FRN issuance that will take place Jan. 29, 2014. Representing the first new Treasury security introduced since inflation-protected securities 17 years ago, the initial FRN auction is expected to be $10 billion to $15 billion in size, with a maturity of two years."
The statement continues, "According to the Treasury, auctions of the FRNs will be conducted similar to other Treasury securities auctions. As such, the Treasury expects to offer the FRNs on a quarterly basis in addition to two monthly reopening auctions. The FRNs will accrue interest based on a rate comprised of the 13-week auction High Rate from the previous 13-week Treasury bill auction (the reference or index rate) and a spread that the Treasury will determine at the initial FRN auction."
S&P explains, "We have received inquiries in anticipation of the first issuance about how we would treat it under our current principal stability fund ratings criteria. We released our criteria for rating principal stability funds, also known as money market funds, on June 8, 2011 (see "Methodology: Principal Stability Fund Ratings," published on RatingsDirect). In our view, the 13-week auction High Rate is consistent with our criteria and, as such, we would not classify the newly issued Treasury FRNs as a higher-risk investment."
In other news, Federal Reserve Bank of New York Executive VP Simon Potter gave a speech Monday entitled, "Recent Developments in Monetary Policy Implementation," to New York University's "Money Marketeers," a group of economists. He said, "My remarks this evening will focus on the role played by the New York Fed's Trading Desk (the Desk) in the implementation of monetary policy and how our operational tools have evolved in recent years. I'll focus in particular on the potential use of overnight, fixed-rate reverse repurchase agreements, also known as reverse repos, which we began testing in September. We've been testing this instrument to support the Federal Open Market Committee's (FOMC) longer-run planning for the implementation of monetary policy, and its development shouldn't be interpreted as a signal of the FOMC's intentions for monetary policy or the path or timing of any future change in the level of policy accommodation."
Potter explained, "An important point to observe is that the rate for which the FOMC sets a target, the overnight federal funds rate, represents an unsecured lending rate between banks. But the Desk conducted its operations with its primary dealer counterparties -- government securities dealers that have an established trading relationship with the New York Fed—in the secured financing market for general collateral repurchase agreements, or GC repos. This market serves as a hub in which broker-dealers and other market participants finance their inventories of securities, frequently borrowing from cash-rich investors, such as money market funds. These financing arrangements are structured as repos, in which the security is technically sold with an agreement to repurchase at an agreed-upon later date. The transaction can be thought of in most respects as economically similar to a collateralized loan. The growth of the GC repo market in recent decades has reflected the greater issuance of marketable securities in the United States, and the repo market and the broker-dealers, through their intermediation, support the healthy functioning of the markets for such securities."
He continued, "The crisis brought on several important changes in the conduct of monetary policy with implications for money markets. The first was the easing in the stance of monetary policy, with the FOMC's reduction in its fed funds target from a point target of 5 1/4 percent in mid-2007 to a target range of zero to 1/4 percent by December 2008, where it remains today. The second change was a shift to liquidity and monetary policy operations that resulted in a high level of excess reserves. In the initial year or so of the crisis, the Desk offset the reserve-adding nature of the Federal Reserve's loans to support the liquidity of a range of financial institutions and to foster improved conditions in financial markets by reducing other assets on the Fed's balance sheet, notably holdings of short-term U.S. Treasury securities. By September 2008, however, amid a deepening crisis and widening policy response, the capacity to offset completely the increase in the balance sheet was effectively exhausted. Consequently, additional credit provision and the initiation of large-scale asset purchase programs, the latter of which continue today to support continued progress toward maximum employment and price stability, began and continue to cause reserve balances to grow."
Potter added, "A third and related change in the conduct of monetary policy was the introduction of our ability to pay interest on reserve balances held by depository institutions. Congress granted this authority to the Federal Reserve in the Financial Services Regulatory Relief Act of 2006, with an October 2011 effective date, but accelerated its implementation to October 2008 as part of the legislative response to the financial crisis. In particular, the ability to pay interest on excess reserves, or IOER -- that is, reserve balances held by banks above the level of reserves they're required to hold -- enhanced the Federal Reserve's ability to control short-term interest rates amid its reserve-expanding credit programs and asset purchases. Without payment of interest on reserves, short-term interest rates could fall to zero or negative levels given the increased level of reserve balances. Interest on reserves represents the rate of return on a riskless overnight deposit at the Fed. Accordingly, the interest rate paid on reserves represents the sure return a bank can earn and therefore the opportunity cost for the bank to make an alternative investment, such as a loan or the purchase of a security. Theoretically, if all money market participants had access to deposits earning the IOER rate, the IOER rate should set a minimum rate -- or floor, so to speak -- on short-term interest rates, as there would be no incentive for institutions to make loans to any institution at a lower rate."
Finally, he commented, "Money market dynamics in recent years generally reflect these changes. In a world with significantly elevated reserve balances and a 1/4 percent interest rate paid on those balances, IOER has kept the federal funds rate and other money market rates at positive levels within the FOMC's zero to 1/4 percent target range. Contrary to the dynamics one would expect of an idealized perfect market, however, short-term rates have consistently traded at levels below the IOER rate, and Treasury bill and repo rates have occasionally gone negative, particularly when financial stresses increase the demand for very safe assets. Since IOER is available only to depository institutions holding balances at the Fed, many other money market participants cannot access it, either because they don't earn interest on Fed account balances (like government-sponsored enterprises, or GSEs) or don't have Fed accounts at all (like money market funds). Without such access, these institutions may have less bargaining power and may have to leave funds unremunerated at the Fed or place funds in the market at sub-IOER rates. This creates a potential arbitrage opportunity for banks, which can earn a spread between their costs of funds and their earnings on reserves, but not for other cash lenders.... Thus, while banks take some advantage of the arbitrage opportunity, competitive conditions in the unsecured money markets haven't proven strong enough to narrow the spread between the fed funds rate and the IOER rate to very small and stable levels, and the floor on rates that IOER is meant to provide appears soft."
