The Federal Reserve Bank of New York announced new Term repos offerings for the March quarter-end in two new statements. The NY Fed's first new "Statement Regarding Term Reverse Repurchase Agreements says, "The Federal Open Market Committee (FOMC) instructed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to conduct a series of term RRP operations that span the March 2015 quarter-end." It continues, "The tests will consist of two term RRP operations: a $75 billion, 14-day operation on March 19 and a $125 billion, 7-day operation on March 30, with any unused capacity from the March 19 operation to be added to the offering size of the March 30 operation. The maturity date for the March 19th operation is April 2, while the maximum ON RRP offering rate is +5 basis points. The maturity date for the March 30th operation is April 6 and the ON RRP offering rate is also +5 basis points." The NY Fed's other Statement explains, "The tests will consist of four one-week term RRP operations to take place on successive Thursdays. The amount offered and maximum offering rate associated with each operation will be announced on or around the Monday prior to the operation."
At the Federal Reserve's Federal Open Markets Committee meeting in January, the board discussed the possibility of raising the ON RRP cap. The minutes for the January 27-28 meeting state, "The presentation discussed the possibility of establishing, on a temporary basis, an aggregate cap for ON RRP operations that was substantially above the cap the Committee had chosen for the purposes of testing such operations. In addition, the presentation discussed the possible use of term RRP operations, either before or after the commencement of policy firming, as a way to reinforce control of short-term interest rates and to manage the size of the ON RRP program."
It continues, "A couple of participants expressed continued concerns about the potential risks to financial stability associated with a large ON RRP facility and the possible effect of such a facility on patterns of financial intermediation.... While acknowledging these concerns, many participants believed that a temporarily elevated cap on the ON RRP operations at a time when the Committee saw conditions as appropriate to begin normalization would likely pose limited risks.... Some participants noted that a relatively high cap could be established and then reduced fairly soon after the initial policy firming if it was determined that it was not needed, and that such a reduction could help underscore the Committee's intent to use such a facility only to the extent necessary. A number of participants emphasized that the Committee should develop plans to ensure that such a facility is temporary and that it can be phased out once it is no longer needed to help control the federal funds rate."
Last week, the Federal Reserve released a paper, "Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations that examines the effects of the facility. It concludes, "An ON RRP facility offers a promising technical advance in the implementation of monetary policy. By making ON RRPs available to a broad set of investors, including nonbank institutions that are significant lenders in money markets, such a facility can complement the use of IOER and help control short-term interest rates. Indeed, the FOMC has stated that it intends to use an ON RRP facility for this purpose during the policy normalization process. At the same time, an ON RRP facility may have important secondary effects with both positive and negative implications."
It continues, "The FOMC has considered a range of issues associated with an ON RRP facility and has directed the Desk to test several design features of ON RRP operations, including some which might be used to address undesirable secondary effects. Results of the testing exercise in place since September 2013 have been quite encouraging and indicate that even capped offerings of ON RRPs can be effective in setting a floor for short-term interest rates. FOMC policymakers have generally agreed upon the importance of a successful commencement of the policy normalization process, and they have indicated that they will be prepared take the steps necessary to keep the federal funds rate within the target range established by the Committee."
In his most recent commentary, JP Morgan Securities' money market strategist Alex Roever says, "This begs the question of whether or not the current $300bn cap on the Fed RRP is sufficient for effectively influencing short-term rates outside of Fed Funds.... Given the regulatory-driven forces suppressing front-end yields, most notably deposit shedding by large banks and money market fund reform, we believe that increasing the aggregate cap on the RRP will become imperative for the Fed. Looking forward, it is likely that the March FOMC meeting will be the next opportunity we have to get more color from the Fed on this issue."
Roever adds, "The prospect of a growing supply-demand mismatch in short-term government securities is going to leave market participants looking to the Fed and hoping for some relief in the form of increased availability for both term and overnight reverse repos. The potential scale of regulation-based inflows into the money markets suggests the program may need to be substantially larger in order to accommodate the marginal demand. At various times, the Fed has expressed concern about upsizing the RRP program for reasons including possible financial instability that could be caused by deposits trying to access the Fed balance sheet as a safe haven during a future banking crisis. Conceivably this could happen if deposits shifted to MMFs that are RRP counterparties."
He adds, "Ironically, while prudential regulations that the Fed helped to put in place are stabilizing the banking system, deposits appear to be shifting from banks into the money markets anyway. Facing a dearth of investible product, MMFs are eyeing the Fed's balance sheet as the asset of last resort. While the Fed could choose not to increase the size of the RRP program in the face of growing demand, not accommodating the marginal demand could complicate the Fed's plans to raise short-term rates beginning later this year. Too much cash chasing too few assets does not make for higher yields."
In her March "Month in Cash" column, "Rate Hike Not the Only Issue to Play Out This Year," Federated Investors' Global CIO for Money Markets, Deborah Cunningham, writes, "You know things are getting interesting when the timing of the Federal Reserve's long-delayed hike in rates is not the most uncertain issue facing cash managers. Liftoff -- probably to another target range rather than a specific number -- is pretty much written in stone for 2015. It is just a question of the timing. At present, we think the move will take place midyear, in one of the two policymaking meetings of June or July. The consensus is around 70% for the hike to be approved at one of those two meetings, and nearly everyone agrees the latest it will come is at the September meeting."
She adds, "What's less clear is what path money funds will take to adapt to the Securities and Exchange Commission's 2014 ruling regarding them. If you recall, the SEC announced that starting in 2016, prime institutional money funds must state the value of its shares down to the fourth decimal place. This means a move from the stable $1 per share to a "floating" net asset value (NAV). There are many strategies out there for money market firms, from transitioning an institutional fund into a retail product (which are permitted to maintain the stable NAV), or changing a fund's composition, such as converting a prime fund into one that invests in government securities. While these potential moves will affect the competitive landscape, their effect on the supply of government debt could be a greater issue. There are plenty of short-term Treasuries available now. But if more players get in the game, the supply could diminish. For example, money currently invested in CDs, commercial paper, and the like could soak up Treasuries and agencies on a massive scale."
Cunningham concludes, "Even as we wait for its big decision, the Fed continues to give us plenty to handle on a weekly basis. It is constantly tweaking its reverse repurchase program (RRP) in an effort to "ensure that this tool will be ready to support the monetary policy objectives of the FOMC." In addition to the $300 billion overnight reverse repo program, the policymakers undertook four smaller weekly term operations and also announced a quarter-end term offering in March. Why all the complication? The Fed is experimenting with how the participants react to rate adjustments. Think of it as a litmus test to see what will work when the Fed raises the federal funds rate. These term reverse-repo offerings have not had a significant effect. Participants are generally not using all the overnight repo as it is, meaning that the Fed's guaranteed five-basis-point return has been often providing that crucial floor for participants."
