As Fed Ponders a New Lever, Here's Wall Street's View

(Bloomberg) -- Wall Street’s abuzz about a new tool Federal Reserve policy makers are studying for managing interest rates.

The Federal Reserve Bank of New York asked primary dealers -- the traders who deal directly with the central bank -- whether it should do something to keep money-market rates from rising too far above the Fed’s target range, people familiar with the discussions have said previously. Although policy makers haven’t been too specific about what they’re considering, economists are advocating for a standing repo facility, which could involve banks converting Treasuries to reserves on demand at an administered rate.

Strategists at Bank of America Corp. and BMO Capital Markets think a plan, if implemented, would indeed keep a lid on rates; others at Goldman Sachs Group Inc. and NatWest Markets are skeptical. JPMorgan Chase & Co. suspects taxpayers would benefit because the facility would tend to reduce the government’s borrowing costs. Barclays Plc argues dealer balance sheets are already too bloated from current regulatory requirements, so it’s not clear they can absorb more assets as would be required from a new Fed program.

Minutes of December’s Federal Open Market Committee meeting indicated that some officials were interested in learning more about possible new tools for exerting greater control on rates. An account of January’s meeting mentioned a year-end spike in rates for repurchase agreements, which occurred during a reduction in overnight lending as market participants shored up balance sheets for regulatory purposes. This drove repo rates to the highest level since 2001.

What the Strategists Say

  • Curvature Securities (Scott Skyrm)
    • Before the Fed introduces a repo facility, there are several questions that need to be addressed, from counterparties to the mechanics; so far, much of the discussion is around the banks, yet the disruptions in the repo market resulted from banks closing their balance sheets.
  • Goldman Sachs (Praveen Korapaty, William Marshall, Avish Thakkar)
    • As the Fed considers a potential repo facility, even the “most plausible design choices” could result in a “somewhat leaky” cap on rates. Click here to read more
  • Barclays (Joseph Abate)
    • If the Fed implements a repo operation -- either a standing one, or one used periodically, say at the end of the month or quarter -- it may be the “wrong solution to the problem” given that the recent pressure in the repo market is due to dealer balance sheets “that are too heavy.” Click here to read more
  • JPMorgan (Alex Roever)
    • The standing repo facility could be good for banks, the Fed’s policy goals and possibly taxpayers. Click here to read more
  • Morgan Stanley (Sam Elprince)
    • Should the Fed introduce a standing repo facility, it would be seen as supportive for U.S. funding markets, potentially taming spikes around quarter- and year-ends. Click here to read more
  • Wrightson ICAP (Lou Crandall)
    • A standing repo facility would be a “valuable addition” to the Fed’s operational framework, yet at this point the two most important questions are who gets to use it and at what price. Click here to read more
  • BMO (Dan Krieter, Dan Belton)
    • The Fed could employ the repo facility as an “additional lever,” because it might be an effective tool in keeping fed funds in the target range, with the rate likely set 25 basis points above the top of the range -- 2.75 percent in the current environment. Click here to read more
  • TD Securities (Priya Misra, Gennadiy Goldberg)
    • If the Fed ends up creating a standing repo facility, it probably wouldn’t resolve the reserve scarcity problem for some banks caused by the central bank’s balance sheet unwind. Click here to read more
  • NatWest Markets (Blake Gwinn)
    • As the Fed wrestles over whether to introduce a standing repo facility, policy makers may “not find the operational risk, market footprint and potential optics issues worth it if it simply means they get to run a slightly smaller balance sheet or repo stress is less extreme on quarter- and month-ends.” Click here to read more
  • Bank of America (Mark Cabana)
    • Following the mention of “new ceiling tools” in the December and January minutes from the FOMC, it’s “quite possible” the Fed rolls something out in the second half of 2019. Click here to read more

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