The Federal Reserve Bank of the New York plans to modify the process used to calculate the Federal Funds Rate and publish a new "Overnight Bank Funding Rate" early next year. In a release entitled, "Statement Regarding Planned Changes to the Calculation of the Federal ate and the Publication of an Overnight Bank Funding Rate," the NY Fed says, "The Federal Reserve Bank of New York (New York Fed) publishes the federal funds effective rate (federal funds rate) on a daily basis. This rate is calculated using data on transactions that occurred in the federal funds market on the previous day. The New York Fed plans to make an improvement to the process for calculating the federal funds rate, as described below. This change is solely intended to make the calculation process more robust, and no inferences should be drawn about the stance of monetary policy from its implementation. In addition, to increase the amount and quality of information available to the public about the overnight funding costs of depository institutions, the New York Fed is preparing to publish an additional overnight rate on its public website. This rate -- referred to as the overnight bank funding rate -- will be calculated based on both federal funds transactions and the Eurodollar transactions of U.S.-managed banking offices." We review this news and also revisit Fidelity's recent moves to change its Cash Reserves Fund to a Government money fund below.
The statement explains, "Changes to the calculation of the federal funds rate and publication of the overnight bank funding rate will be implemented after revisions to a Federal Reserve data collection are complete, which is expected within approximately one year. The New York Fed will announce an implementation date and additional information closer to the effective date of the change. In light of recent international focus on best practices for reference rates, the New York Fed reviewed the process for calculating the federal funds rate. As a result of this review, the New York Fed intends to enhance the federal funds rate calculation process by transitioning the data source from data supplied by federal funds brokers to transaction-level data collected directly from depository institutions. This Federal Reserve data collection (the FR 2420) was initiated in April 2014 and collects data on unsecured money market borrowing by depository institutions on a daily basis. These data include both trades executed through brokers and those negotiated directly between counterparties."
The New York Fed adds, "The FR 2420 report collects data on several types of unsecured borrowings by depository institutions. In the overnight tenor, these data comprise both federal funds and Eurodollar transactions, which collectively represent a substantial proportion of banks' overnight borrowings. Currently, there is little transaction-based information available to the public on broad overnight funding costs for U.S.-based banking offices. In order to provide insight into these costs, the New York Fed expects to begin publishing an overnight bank funding rate that is calculated using transactions in both federal funds and Eurodollars.... The overnight bank funding rate is expected to be published daily based on trades executed on the previous day, as reported on the FR 2420. The publication of this rate will commence after revisions to the FR 2420 collection are complete."
Wells Fargo strategist Garret Sloan says in his daily commentary that the move could make it more volatile. "Instead of utilizing quotes from brokers, the Fed will now collect actual transaction level data directly from banks that execute Fed funds trades, including direct bank-to-bank transactions that do not execute through brokers. The data is likely to capture transactions that are meant to be kept quiet. In other words, the data should capture trades that in the past could have tipped the market to funding stresses. The result may be that Fed funds effective rates, in general, will become more volatile going forward. For now, with Fed funds essentially existing as an FHLB-driven market, the nuances of the Fed funds rate may seem less important. What we do learn from this revised calculation method is that the Fed is not abandoning the Fed funds rate as a primary benchmark for conducting monetary policy."
He adds, "While the Fed is not abandoning the Fed funds rate, it is expanding the rates it uses to calculate actual bank funding costs. One of the issues with the Fed funds market is that it only looks at funding levels transacted in the U.S. between banks. The Fed's new data set, the Overnight Bank Deposit Rate will incorporate all Fed funds transaction data plus all other overnight unsecured funding that banks receive from other sources, including money market funds and other large sources of overnight cash. The broader Overnight Bank Deposit Rate will be an interesting supplement to measure the perceived funding nuances between inter-bank and external bank funding sources."
In other news, reaction continues from Fidelity's plan to convert 3 Prime money market funds to Government funds, including the $114 billion Fidelity Cash Reserves fund. (See our Jan. 30 "News", "Fidelity Announces Major Changes to MMFs; Staying Stable, Going Govt.") Bloomberg writes, "Fidelity Changes Largest Money Fund to Buy Government Debt. The piece provides a brief recap and quotes our own Peter Crane as saying, "The large retail funds all have to be asking themselves if they have to follow suit.... The big question is whether the government space is big enough to hold all of that money."
JP Morgan's Short Duration Strategy team also commented on the news. They write, "This is the first major strategic announcement that we are aware of from a MMF family since the new SEC rules were finalized in July 2014.... We believe the goal of these moves is to ensure that all existing shareholders will be able to continue to participate in stable NAV funds that are not subject to redemption restrictions (i.e., government MMFs).... For retail investors, which the new SEC rules define as "natural persons," it is quite possible many of these retail shareholders will redeem and migrate away from government MMFs."
JPM adds, "The new SEC rules allow them to continue to invest in stable NAV prime MMFs, a product very similar to what they currently hold. For institutional investors, they are given a choice of staying in the government MMFs or reallocating into a floating NAV prime MMF or some other form of investment, as the new SEC rules exclude non-natural persons from participating in stable NAV prime MMFs." On the likelihood of shareholders leaving the transitioning funds, they write, "[W]hile we suspect many of the affected shareholders will ultimately re-align with prime funds, it is not clear how quickly this might happen. The current low level of money market yields doesn't offer much incentive to shift quickly, but the onset of higher rates later this year or in 2016 might change that.... There are a wide range of business models across the MMF segment of the asset management industry, and while some may follow Fidelity's lead, others will chart their own route with their own timetables."
