Jackson Hole, Wyoming was the center of the economic universe Friday as Federal Reserve Chair Janet Yellen was the featured speaker at the annual Economic Policy Symposium, sponsored by the Kansas City Federal Reserve. Interest rates were a hot topic, but there was also some discussion of the Fed's reverse repo program by St. Louis Fed President James Bullard during an interview with Bloomberg. In her keynote speech Friday morning, Chair Yellen said the Fed is waiting for further recovery in the job market before moving on interest rates. "At the FOMC's most recent meeting, the Committee judged, based on a range of labor market indicators, that "labor market conditions improved." Indeed, as I noted earlier, they have improved more rapidly than the Committee had anticipated. Nevertheless, the Committee judged that underutilization of labor resources still remains significant. Given this assessment and the Committee's expectation that inflation will gradually move up toward its longer-run objective, the Committee reaffirmed its view "that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after our current asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.""
She continued, "But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy," said Yellen.
Committee members remain divided on when rates will go up. Bullard predicts late first quarter of 2015, while others, like Atlanta Fed president Dennis Lockhart, say mid-2015, according to Bloomberg <iEhttp://www.businessweek.com/news/2014-08-22/u-dot-s-dot-index-futures-little-changed-before-yellen-speaks>`_.
In a live interview from Jackson Hole, Bullard talked to Bloomberg Radio's Kathleen Hays about a range of topics, including the Fed's reverse repo program. Writes Bloomberg reporter Matthew Boesler, "The Federal Reserve will probably borrow "several hundred billion" dollars from money-market mutual funds and others to anchor the federal funds rate when it begins tightening policy, according to St. Louis Fed President James Bullard. "I don't think it would have to be that large of a program. Possibly several hundred billion would be enough," Bullard said, referring to the Fed's overnight reverse repurchase facility, which it has been testing since September. "If that didn't work, the committee could revisit that and increase the size of the program if we thought that was necessary." ... The central bank has been testing overnight reverse repos with a limited set of counterparties, mostly money funds, as a tool to set a floor under short-term interest rates when it begins guiding those rates higher, an event Fed officials forecast to occur in 2015."
In his daily newsletter, Wells Fargo Securities strategist Garrett Sloan commented on the RRP. Writes Sloan, "The expansion of the repo program would represent a significant increase in the amount of repo sitting in money market funds, and could possibly cause some "crowding out" in front-end markets, forcing issuers to increase rates even further to entice buyers. This would most likely be true in credit-related markets, while we could potentially see other government-related products such as bills and very short coupons lag the increases. This kind of "policy leakage" is not likely a concern for the Federal Reserve unless it gets completely dislocated from other short-term rates."
J.P. Morgan Securities latest "Short-Term Fixed Income" says of the RRP program, "The likelihood that the Fed will extend the facility beyond its current sunset date of January 30, 2015 is almost certain at this point. Until then, the minutes noted that further testing could be done to limit the Fed's role in financial intermediation and mitigate run risks to the Fed during periods of financial market stress. In what form these additional tests could come in remains to be seen. Based on various Fed speeches and FOMC minutes, the Fed seems keen to include design features that could limit the program size while still be able to set a firmer floor under money market rates during normalization. To that end, it's possible that the Fed may test an aggregate cap on the RRP facility alongside or instead of the current allotment limit per counterparty."
Authors Alex Roever, Teresa Ho, and John Iborg add, "While the Fed is set to use the RRP facility during the normalization process, the minutes also noted that the RRP facility will only be a temporary facility, used as needed for effective monetary policy implementation. Eventually, the program will be phased out when it is no longer needed for that purpose. If this were to occur, this could of course become problematic for government money funds down the road to the extent that government supply continues to shrink and flows into government money funds remain prevalent post the implementation of money market reform in late 2016. As it stands, the RRP facility has been both a reliable and useful source of backstop supply for MMFs."
Finally, commenting on the Fed's reverse repo strategy from the July 29 FOMC minutes, Citi Research strategist Andrew Hollenhorst wrote "Consistent with the tone of the last minutes, "participants generally agreed that the ON RRP facility should be only as large as needed for effective monetary policy implementation." As we have previously discussed, recent reforms may increase money market mutual fund demand for repo and short-term government assets and reduce bank supply of repo and other short-term investments. The Fed may need to reconcile a fixed policy rate with the increased demand for and limited supply of short-term government assets by allowing the size of the RRP facility to grow. The RRP facility was characterized as "temporary" but in our view the large size of the Fed balance sheet may make RRP a necessary tool for flooring rates for the next few years at least."
