Fed's reverse repo programme
Just read the following in the ft: "The central bank has been testing so-called reverse repo programme that will see it lend out securities from its vast portfolio of assets to money market funds. This enables the Fed to drain money from the financial system and better control short-term interest rates."
My questions:
1) Money market funds usually make profit by borrowing and lending out money out for a short period - why would they lend securities?
2) How can the Fed in this example control st ir?
Thanks in advance
1) Firstly, the MMFs would borrow from the Fed, rather than lend. They would do this because this allows them to earn the prevailing rate w/o any risk and w/o the need to pay any fees to money-mkt intermediaries.
2) The presence of the repo facility will ensure that there's a floor to short-term rates. Specifically, it would make it uneconomical for anyone to lend in the overnight mkt (however that lending is structured) at a rate that's lower than the repo facility rate.
What is the overnight funding rate and how is using the reverse repo take away pressure from Fed Funds Rate? Understand it reduces cash from banking system but is it to alleviate demand for treasuries hence less pressure on driving rates down?
.05% if I recall. The purpose as far as I know is to keep short term rates down and prevent yield curve inversion.
Thanks for the quick answer. Just two follow up questions:
1) Why would a mmf borrow securities from the Fed? What would they do with it? I thought they only BUY st securities or take them as a collateral when they lend out money.
2) Why would the overnight mkt exhibit lower ir?
Thanks again!
1) Leave cash at Fed because no dealer has better ctpy credit. To compete dealers would need to pay a rate above the repo facility rate, hence the floor. This also answers 2), o/n rates would be higher if full allotment repo facility is in place
1) Consider this... You're a MMF, you gots cash, you gots securities, you gots all sorts of things that you're sitting on. Most importantly, what you gots is a mandate, which implies that you need to, at least, make a return that's not too far off the prevailing short rate. Contrary to what one might imagine, it's not too easy to make this return safely. So if the Fed gives you a 100% safe way to earn this money directly, you would certainly want to take advantage of it.
2) It wouldn't, that's exactly the point. The repo facility gives the Fed the ability to impose a firm floor on rates.
Just to be more precise, money market funds are borrowing securities overnight and lending cash to the Fed. In other words the Fed repos out Treasuries and drains cash while MM funds reverse Treasuries in and makes a loan to the Fed, earning the repo rate.
Guys, thank you so much, I think I finally got it!
Are they doing just Treasuries or MBS, or both?
For the ongoing test phase it's just treasuries, though SOMA holdings of Agencies and MBS could be available for use in future. Sellers of collateral in the repo market tend to pay a higher rate for Agencies and MBS due to higher perceived credit risk, but if the Fed is doing repo, would imagine rate would be uniform across SOMA holdings.
They say it's expected to be just treasuries...
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