FT on Fed's RRP
The Financial Times posted a story, "Federal Reserve Sharpens Tools for Lift-off." It reads, "Engineering the great escape from near-zero interest rates will present the Federal Reserve with a universe of challenges. A key one is ensuring short-term market interest rates obediently head where the Fed wants to see them. Achieving this is going to be a daunting feat for a central bank facing a financial sector that has changed radically following the crisis. Markets specialists at the New York Fed have for two years been extensively road-testing a new toolkit aimed at setting short-term rates in this new world, but success will only be judged when lift-off actually occurs. Some analysts argue the operation could lead to unexpectedly choppy movements in financial markets. Zoltan Pozsar, a former adviser at the US Treasury and now director at Credit Suisse, warns: "This could be a turbulent process." It continues, "A key question is how effective the new tools will be in terms of influencing market rates. Given the importance of the central bank proving it is firmly in charge of its key policy rate, many investors say they are confident the Fed will pull it off. `Brian Jacobsen, chief portfolio strategist at Wells Fargo Fund Management, said: "I'm pretty confident they will be able to hit the target they want. The [RRP] is the really potent tool <b:>`_. They can use that to enlist the money market industry." Further, "Fed chair Janet Yellen has said the size of the RRP programme will be "elevated" when rates are first lifted, but that it will be quickly reduced in size thereafter. Ben Bernanke, the former Fed chairman, has on the other hand suggested the RRP should be a permanent feature of a big central bank balance sheet. `Joseph Gagnon, a former Fed official, now with the Peterson Institute for International Economics and who co-authored a key paper on the topic in 2014, argues this flight risk has been exaggerated and that the RRP will either have to be "very big or unlimited in size" if it is to work well. It is currently capped at $300bn.... "If depositors move from banks to money market mutual funds, then many of those deposits will stay with the MMFs and the RRP will need to be permanent." Mr Pozsar says tougher regulations under Basel III will encourage many banks to shed institutional deposits that are costly to maintain, and billions could flow out of non-interest bearing deposits and into MMFs when interest rates rise. He and his colleague James Sweeney have argued the RRP will have to become very big -- north of $1tn -- as rates rise.... The cost of having a full-allotment RRP is massive flows of money from the banks and into the money funds that will be users of the RRP, and this creates problems of its own, Mr Pozsar added. "These huge flows of cash could generate volatility in the financial markets. For example, individual banks could face unexpected bottlenecks."
