While in theory yesterday's FOMC Minutes said little that wasn't known (except for the admission that the "equilibrium [3]" real interest rate is now well longer than historically) with markets now almost fully-pricing in a December rate hike (and in the case of some assets such as CHF negative swap spreads, more than fully), in practice there was one glaring ommission from the Minutes. Namely - the logistics of the proposed rate hike, or, well, the "practice."
As Jefferies economists Ward McCarthy and Thomas Simons write in note, if December 16 is "indeed the liftoff date, the Fed is running out of time to be 'well before' raising rates."
As Bloomberg reminds us, in the July 29-30 minutes, FOMC participants agreed the committee should provide additional information to the public regarding details of normalization well before first steps in reducing policy accommodation.
And yet, aside from some vague reassurance that the Reverse Repo - IOER corridor "should" work, there has been no detail on the topic. To Jefferies this is a glaring problem: "The lack of any discussion of liftoff logistics is puzzling to us and a potentially significant communication snafu."
Jefferies adds that the Fed has never attempted to raise fed funds rate under "IOER regime" so lack of confidence "is not unreasonable."
In the note, the authors write that still unresolved issues about liftoff logistics and normalization process include:
- Issues include how to communicate liftoff, spread between IOER and RRP, as well as spread between RRP rate and fed funds
- FOMC members still struggling with risks associated with RRP facility, including “appropriate size” that would limit Fed’s role in financial intermediation
And then there is uncertainty “about the efficacy” as how combination of RRP and IOER rates will control fed funds rate
The punchline: Jefferies says that the idea that IOER will be primary tool to move fed funds rate is "wishful thinking" as IOER was initially intended to put floor under fed funds rate yet hasn’t been "an effective tool for doing so."
Where it gets more problematic is that while the RRP usage has “varied significantly” throughout test phase, fed effective has been “relatively steady,” indicating there hasn’t been a strong relation between RRP and fed funds rate. One correlation that has emerged is that RRP usage has inverse relationship to bill supply as T- bills fell during September and October, facility utilization increased. Or as we have said before, most banks have been using the RRP not as an indicative benchmark rate, but as a facility with which to window dress their books.
For Jefferies this suggests availability of “alternative investment options” beyond RRP will reduce "downward gravitational pull" on short-term rates due to the “enormous supply of liquidity sloshing around the system” and will also increase strength of the “magnetic field of the IOER on short-term rates”
Finally, it is worth noting that yesterday after the Minutes release, the NY Fed announced [4]that it "plans to offer $300 billion in term RRPs that cross the year-end date. These operations will be conducted in addition to the authorized overnight RRPs, which remain subject to a separate overall size limit authorized by the FOMC. A tentative schedule of the term operations spanning the year-end follows below. This schedule will be updated on or around December 17 with additional information, including the amounts offered and the maximum offering rates."
Why December 17? Because that is the day after the alleged FOMC rate hike announcement.
The schedule is shown below.
[5]
Why only $300 billion? If together with overnight RRPs these are meant to satisfy year end window dressing demand, this token amount will be nowhere near enough to push up the trillions in liquidity sloshing at the zero-lower bound.
And the biggest unanswered question: when the NY Fed was implementing these term repos, was it assuming the current ZIRP rate, or will the repos take place assuming 25 bps of interest.
With everyone confused, and even more questions set to be unveiled about the liftoff corridor, the fact that less than a month from a proposed December rate hike few are discussing the practical matters of normalization, let alone have any answers, shows just how behind the rate hike curve the Fed really is... assuming in fact it has any intention of hiking rates in the first place.
