NY Fed's Potter on Rates, IOR
Federal Reserve Bank of New York Executive VP Simon Potter spoke recently on "Confidence in the Implementation of U.S. Monetary Policy Normalization." He commented, "My remarks today will focus on the implementation of monetary policy normalization in the United States and its contribution toward maintaining stability in U.S.-dollar money markets.... Then, I will discuss the recent technical adjustment to the rate of interest paid on reserves (IOR). The Federal Reserve made the adjustment to provide greater comfort that the effective federal funds rate would remain within the target range set by the FOMC.... I will then conclude with some comments on recent developments in broader money market rates, in particular U.S.-dollar LIBOR. U.S. term money market rates are of global significance, owing to the heavy use of the dollar outside the United States and the large stock of dollar-LIBOR-linked debt issued abroad." Potter commented on, "First: overnight rates. Due to the large supply of reserves that has accompanied the Federal Reserve's expanded balance sheet, we are employing a new and innovative framework to control money market rates. Before the financial crisis, the Federal Reserve followed a well-worn playbook for monetary policy implementation that was based on keeping reserve balances scarce. Nowadays, however, reserves are no longer scarce. Our current framework relies, instead, on providing the market with two overnight investment opportunities to help steer money market rates: interest on reserves (IOR), which is the Federal Reserve's main tool to control interest rates, and the overnight reverse repurchase agreement (ON RRP) facility, a secondary tool." His speech continued, "Let's spend a few minutes exploring what drivers might have been most significant in bringing about the rise in money market rates relative to IOR. Leading into the technical adjustment, a shift in flows in the Treasury market had the effect of pushing both Treasury bill yields and repo rates higher in February and March. Before these developments, Treasury bill yields and repo rates had been well below federal funds rates." Finally, Potter said, "Taking a step back, it is hard to be definitive on the recent drivers of moves in short-term money markets. The markets have economically complex structures, and in particular, a high degree of concentration within some money market segments.... Indeed, despite a recent decline in repo rates, the effective federal funds rate has remained fairly stable at nine basis points below the top of the range."
