The Federal Reserve raised interest rates yesterday for the first time in almost 10 years, lifting its Federal Funds rate off its zero to 0.25% range to a new 0.25%-0.50% range. (See the Fed's Statement here.) The historic move by the FOMC ends a seven-year yield drought for money funds -- the Fed Funds rate has been at virtually zero since December 2008. Money market fund yields should jump starting today; they've already moved higher in anticipation of the hike. Our Crane 100 Money Fund Index has increased from 0.03% at mid-year to 0.07% today. MMF yields should move higher by about 10 basis points over the next week and up to 25 bps by mid-January (though this will depend on how much of the hike is absorbed by the removal of fee waivers). In support of the Fed's move, the Federal Reserve Bank of New York announced that it was temporarily raising the cap on the Fed's Overnight Reverse Repo Program to $2 trillion.
The Fed's Press Release says, "The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation."
It continues, "In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information.... The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way."
In her press conference, Fed Chair Janet Yellen explained, "This action marks the end of an extraordinary 7 year period during which the federal funds rate was held near 0 to support the recovery of the economy from the worst financial crisis and recession since the Great Depression.... With the economy performing well and expected to continue to do so the committee charged that a modest increase in the Federal Funds Rate target is now appropriate, recognizing that. Even after this increase, monetary policy remains accommodative. The process of normalizing interest rates is likely to proceed gradually."
Yellen added, "Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly at some points to keep the economy from overheating and inflation from significantly over shooting our objective. Such an abrupt tightening could increase the risk of pushing the economy into recession."
The Fed's updated "dot plot" economic projections for rates shows expectation for 4 more rate hikes by the end of 2016, with the Fed Funds reaching 1.4%, and 5 more hikes in 2017 with the rate reaching 2.6%. By the end of 2018, the rate is expected to be at 3.5%. Yellen added, "Compared with the projections made in September, a number of participants lowered somewhat their paths for the Federal Funds Rate, although changes to the median path are fairly minor. However the actual path of the Federal Funds Rate will depend on the economic outlook as informed by incoming data."
In concert with the rate increase, the NY Fed released a "Statement Regarding Overnight Reverse Repurchase Agreements." It says, "During its meeting on December 15–16, 2015, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York (New York Fed), effective December 17, 2015, to undertake open market operations as necessary to maintain the federal funds rate in a target range of 1/4 to 1/2 percent, including overnight reverse repurchase operations (ON RRPs) at an offering rate of 0.25 percent, in amounts limited only by the value of Treasury securities held outright in the System Open Market Account (SOMA) that are available for such operations and by a per-counterparty limit of $30 billion per day <b:>`_."
It continues, "[T]he Desk anticipates that around $2 trillion of Treasury securities will be available for ON RRP operations to fulfill the FOMC's domestic policy directive.... These ON RRP operations will be open to all eligible RRP counterparties, will settle same-day, and will have an overnight tenor unless a longer term is warranted to accommodate weekend, holiday, and other similar trading conventions. Each eligible counterparty is permitted to submit one proposition for each ON RRP operation, in a size not to exceed $30 billion and at a rate not to exceed the specified offering rate. The operations will take place from 12:45 p.m. to 1:15 p.m. (Eastern Time)."
On the RRP, Yellen added, "We also released an implementation note that provides details on the tools that we are using to raise the Federal Funds Rate into the new target range. Specifically, the board of governors raised the interest rate paid on required and excess reserves to one half percent and the FOMC authorized overnight reversed repurchase operations and an offering rate of one quarter percent. Both of these changes will be effective tomorrow. To ensure sufficient monetary control at the onset of the normalization process, we have for the time being suspended the aggregate cap on overnight reverse repurchase transactions that's been in place during the testing phase of this facility. Recall that the committee intends to phase out this facility when it is no longer needed to help control the Federal Funds Rate. We will be monitoring financial market developments closely in the coming days and are prepared to make adjustments to our tools if that proves necessary to maintain appropriate control over money market rates."
As we mentioned, money market mutual fund yields should begin rising in earnest starting Thursday. (We'll first see the yield jump in Friday morning's Money Fund Intelligence Daily.) Yields have risen gradually the last two weeks. Several Institutional funds are now yielding over 0.20%, their highest level since late 2012, and several Retail MMFs are now yielding over 0.10%. (See our Top 5 rankings on the www.cranedata.com homepage.) We initially expected about half of the Fed's increase to be absorbed by lower fee waivers, but we now believe that most of the hike will be passed through to investors.
Nonetheless, the quarter-point move, and market expectations of more in 2016, should bring a desperately needed boost to money fund managers' bottom lines. Funds have already seen almost a billion dollars more in annualized revenue as charged expenses have increased from 0.14% to 0.18% in 2015, and another 5-10 bps of fee waiver relief should bring an additional $1.5 billion to $3.0 billion in added (or restored) revenue in 2016. We'll keep you posted on yield and expense levels in the coming days as fund portfolios adjust to the new higher-yielding securities, and as markets begin speculation on when the Fed will next increase rates.
