As expected, in addition to raising the Fed Funds rate by 25 bps, the Fed similarly noted that it would revise the mechanics behind its reverse repo operations, raising the rate it charges on reverse repos by 25 bps to 0.5%, the actual means by which the Fed will hike rates for most market participants.
Here is the statement that the Fed released regarding the change in overnight reverse repos:
During its meeting on December 13-14, 2016, 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 15, 2016, to undertake open market operations as necessary to maintain the federal funds rate in a target range of ½ to ¾ percent, including overnight reverse repurchase operations (ON RRPs) at an offering rate of 0.50 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.
To determine the value of Treasury securities available for ON RRP operations, several factors need to be taken into account, as not all Treasury securities held outright in the SOMA will be available for use in such operations. First, some of the Treasury securities held outright in the SOMA are needed to conduct reverse repurchase agreements with foreign official and international accounts.1 Second, some Treasury securities are needed to support the securities lending operations conducted by the Desk. Additionally, buffers are needed to provide for possible changes in demand for these activities and for possible changes in the market value of the SOMA’s holdings of Treasury securities.
Taking these factors into account, the Desk anticipates that around $2 trillion of Treasury securities will be available for ON RRP operations to fulfill the FOMC’s domestic policy directive. In the highly unlikely event that the value of bids received in an ON RRP operation exceeds the amount of available securities, the Desk will allocate awards using a single-price auction based on the stop-out rate at which the overall size limit is reached, with all bids below this rate awarded in full at the stop-out rate and all bids at this rate awarded on a pro rata basis at the stop-out rate.
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). Any changes to these terms will be announced with at least one business day’s prior notice on the New York Fed’s website.
The results of these operations will be posted on the New York Fed’s website. The outstanding amounts of RRPs are reported on the Federal Reserve’s H.4.1 statistical release as a factor absorbing reserves in Table 1 and as a liability item in Tables 5 and 6.
So how does the Fed actually implement these changes?
The New York Fed trading room in 1953.
Here is a primer from the WSJ explaining how the Fed's trader will effectuate the Fed Fund rate change:
When the Federal Reserve moves to raise interest rates, the action will be centered in a small room overlooking lower Manhattan where a digital timer hangs from the ceiling like a shot clock at a basketball game and a video camera links the central bank’s traders to their counterparts in other cities.
Lining one wall are trading terminals and framed black-and-white photos of Fed employees carrying out market operations decades ago. Phones in the room provide the central bank with direct lines to Wall Street banks.
Officials on the trading desk at the Federal Reserve Bank of New York, which implements changes in rate policy, have spent more than three years tinkering with their tool kit for lifting borrowing costs. Last December, when they raised the policy rate for the first time since 2006, their tools worked smoothly.
To raise rates, traders in the New York Fed markets division perform a series of maneuvers designed to lift the policy rate into the target range—which in turn influences other borrowing costs, such as Treasury yields and rates on mortgages, credit cards and business loans.
The Fed traders enter higher rates into an electronic system called FedTrade. There is one version of the system for the Fed and another for banks and other Wall Street firms that are eligible to trade with the central bank.
A set of Fed traders operates the FedTrade system, with at least one of the central bank’s traders in a separate location, linked by phone and videoconference, and an additional senior Fed official on the line. The phones in the operations room provide a backup for the central bank to call firms if there are problems with FedTrade.
Since last December, the Fed has held the fed-funds rate in a range between 0.25% and 0.5%. When it next raises rates, it is likely to nudge that band up by a quarter-percentage point.
When the implementation day arrives, the Fed will pay higher rates on the money banks park in their accounts at the central bank, called reserves. Currently, the Fed pays 0.5% on reserves. After the next increase, it is likely to pay 0.75%.
That afternoon, the Fed will lift the rate it pays on trades called reverse repurchase agreements, or reverse repos. In these, the central bank borrows from money-market funds and others in exchange for Treasurys. A countdown clock appears when FedTrade opens for repos at 12:45 p.m. EST, which changes to yellow and then to red as the operation completes, generally by 1:15 p.m.
Currently, the Fed pays 0.25% on reverse repos. After the next increase, it is likely to pay 0.5%.
As a result of these moves, the fed-funds rate is supposed to float between the 0.5% repo rate and the 0.75% rate on bank reserves.
This process was used last December to lift the range by a quarter percentage point. It was developed in recent years to replace the old practice, in which the Fed controlled the fed-funds rate by buying or selling U.S. Treasurys, adding or draining the total amount of reserves in the banking system. Small changes in reserves moved rates up or down. Fed staffers called bankers several times a day to get the prices of government bonds and wrote them on chalkboards. Those boards were erased for the last time in 1996.
Since the financial crisis, the Fed has flooded the system with reserves to keep rates very low, making it harder to control the fed-funds rate the old way.