‘Fed needs to en­dorse for­eign banks role in rate raise’

The Pak Banker - - COMPANIES/BOSS -

For­eign cen­tral banks are play­ing a larger role in the Fed­eral Re­serve's plan to in­crease in­ter­est rates, largely at the ex­pense of do­mes­tic money funds. What drains liq­uid­ity, has never been men­tioned by a Fed­eral Re­serve of­fi­cial, and is grow­ing fast? The US cen­tral bank's for­eign overnight re­verse re­pur­chase agree­ments (RRPs) of course!

While much of the fo­cus has been on the RRPs the Fed is un­der­tak­ing with U.S. banks and money mar­ket funds in or­der to re­verse years of easy mon­e­tary pol­icy and raise bench­mark in­ter­est rates, less at­ten­tion has been paid to a sim­i­lar pro­gram of­fered to for­eign cen­tral banks. A new pa­per by Zoltan Pozsar, an­a­lyst at Credit Suisse Group AG, sheds light on the ex­tent to which for­eign cen­tral banks have been tap­ping the fa­cil­ity, largely at the ex­pense of money funds. "Many clients have asked the Fed about the for­eign RRP fa­cil­ity, and the re­sponse they got was that it is just a ser­vice of­fer­ing for for­eign banks. But in our view it is more than just a ' ser­vice of­fer­ing," writes Pozsar, mean­ing that the fa­cil­ity has be­come a key cog in the cen­tral bank's rate-rais­ing ma­chin­ery. In­deed, at a time when do­mes­tic take-up of the RRP has been far less than ex­pected-at about $80 bil­lion and fall­ing-the for­eign RRP fa­cil­ity cur­rently stands at $220 bil­lion and is fast in­creas­ing.

The for­eign RRP pro­gram pri­mar­ily sees for­eign cen­tral banks trade out of short-term U.S. Trea­sury bills in ex­change for cash, ef­fec­tively drain­ing ex­cess liq­uid­ity from the sys­tem and with the bonus re­sult of free­ing up T-bills for other in­vestors. Since the start of last year, for­eign cen­tral banks have traded out of $120 bil­lion of bills, Pozsar notes, and in­vested in an equiv­a­lent amount in the for­eign RRP fa­cil­ity in two waves: $60 bil­lion in the first-half of 2015 and an­other $60 bil­lion in the third quar­ter.

Since the Fed's rate hike in De­cem­ber, how­ever, the in­ten­sity of the sales ap­pear to have ac­cel­er­ated though the deals have a nat­u­ral cap of an­other $300 bil­lion-or the amount of T-bills cur­rently held by for­eign banks ac­cord­ing to U.S. Trea­sury Depart­ment data.

Us­ing the for­eign RRP pro­gram al­lows the cen­tral bank to push yields on T-bills up­wards while en­cour­ag­ing big in­vestors to move out of cash and into the bill mar­ket, thereby lift­ing rates. It is lit­er­ally pulling rates up by their T-bill boot­straps, though much of the pro­gram re­mains a mys­tery. "The pric­ing of the for­eign RRP fa­cil­ity is a key piece of the puz­zle," says Pozsar. While the Fed pub­lishes the rate it pays on overnight bor­row­ings through RRPs with both do­mes­tic money funds and pri­mary dealer banks daily, the rate on the for­eign RRP fa­cil­ity "takes a bit of de­tec­tive work to find," he notes. Deep in the Fed's unau­dited quar­terly fi­nan­cial state­ments is where the pub­lished rate lies-thought not, in­trigu­ingly, in the cen­tral bank's au­dited an­nual state­ments. A glance at the below Credit Suisse chart, show­ing rates paid for do­mes­tic RRPs (the thick blue line and the thin or­ange line) and for­eign RRPs (the thick red line) re­veals some in­ter­est­ing trends. A regime shift oc­curred in 2015, with the for­eign rate eclips­ing both do­mes­tic rates, but that con­ceals a wide dis­per­sion of rates paid for dif­fer­ent bills, as shown in the se­cond chart.

"The New York Fed ap­pears to be pric­ing the for­eign RRP op­por­tunis­ti­cally," says Pozsar, thereby en­cour­ag­ing for­eign cen­tral banks to off­load cer­tain hold­ings of T-bills at cer­tain times. In­deed, rates paid for T-bills with one- and three­month du­ra­tions have been sub­stan­tially higher than the equiv­a­lent se­cu­ri­ties' yields to en­cour­age such a shift. As noted by Matt Boesler of Bloomberg News, ex­pan­sion of the for­eign RRP pool could also be a sign that large U.S. banks are telling for­eign cen­tral banks to take their ex­cess dol­lars else­where. In­deed, Pozsar notes in his pa­per that the de­posit out­flows widely ex­pected to come out of U.S. banks as a re­sult of the RRPs have ma­te­ri­al­ized faster than fore­cast and in the face of the smaller-than-ex­pected take-up of the do­mes­tic fa­cil­ity. Back to the for­eign RRP pro­gram it­self, chan­nelling Rickie Ric­cardo Pozsar writes that: "De­spite this very suc­cess­ful ex­per­i­ment, the New York Fed has some ex­plain­ing to do. First for a fa­cil­ity that ap­pears to be more mean­ing­ful than the overnight RRP fa­cil­ity-both in terms of the amount of re­serves it helped drain and the im­pact it has on short-term rates-it is a touch odd to us that the for­eign RRP fa­cil­ity has never been men­tioned in FOMC min­utes be­fore. That flies in the face of cen­tral bank trans­parency."

"Se­cond, given that the for­eign RRP rate has such a great in­flu­ence on bill yields and is an ef­fec­tive tool to man­age the sup­ply of bills avail­able for cash pools, its pric­ing should be more trans­par­ent and avail­able at a higher fre­quency. Dis­cuss." In­deed, the machi­na­tions of for­eign cen­tral banks when it comes to their port­fo­lios of T-bills is no small mat­ter and stands in stark con­tras to pre­vi­ous ex­pec­ta­tions that the do­mes­tic RRPs would prove a huge boon to money mar­ket funds, who would en­joy an in­flux of in­vestors search­ing for higher rates of re­turn with the added bonus of re­serve ac­counts held at the Fed. In­stead, thanks to a freed-up sup­ply of T-bills, buy-side in­vestors now have the op­tion of in­vest­ing in money funds or run­ning their bill port­fo­lios them­selves.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.