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At the FOMC meeting in July, the Fed unveiled two new repo facilities, They are the Standing Repurchase Agreement Facility and the Standing FIMA Repurchase Agreement.
If the word “Standing” is removed, the two tools will be familiar, and their function will be similar.
The minutes of the June meeting begin with a discussion of the feasibility, strengths and weaknesses of the two tools.
The reason I didn’t write too much about it at the time was that I didn’t think either of these tools would be introduced very quickly at this point in time, and I was very surprised to see these two new tools being introduced at the July conference.
The Fed accomplished this by providing temporary short-term liquidity (deposits) through repo transactions — purchases of securities — in the face of liquidity demands from various counterparties.
Note that in the Fed context, a repurchase facility is a liquidity facility and a reverse repurchase facility is a liquidity facility. The recent hot topic of overnight reverse repurchase is used to withdraw excess liquidity in the system, and the two new repurchase tools are both used to release liquidity.
Figure 1: Balance sheet when counterparty is primary dealer and SRF instrument is used
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Figure 2: The counterparty is the bank and the balance sheet when using the SRF facility
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Figure 3: Counterparties are the balance sheets of overseas central banks using the SFIMA facility
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What are SRF and SFIMA for?
As we can see from the balance sheet diagram above, the essence of the SRF and SFIMA instruments is to immediately convert a counterparty’s risk-free assets with a long duration into overnight liquidity, i.e., reserves/deposits, in a timely manner.
The parameters of the two tools are similar, with SRF at a $500 billion/day cap and SFIMA at a $60 billion/day cap for a single counterparty. By rough calculation, the Fed has the flexibility to pump more than $1 trillion of liquidity through its two tools.
Currently, SRF eligible collateral is US Treasuries, agency debt and MBS, while SFIMA eligible collateral is US Treasuries. The eligible collateral covered by both instruments is assets already held on the Fed’s balance-sheet.
In addition, the interest rates on both facilities are set at 25bps, the current top of the fed’s rate management range, flat with the primary credit rate at the discount window.
Why is it odd at this point to have these two tools on standby?
As mentioned above, I’m surprised to see both of these tools on stand-by at this point in time, starting with the repo market turmoil in 2019 and the FIMA launch at the end of March 2020.
SRF and SFIMA have three meanings for the Fed, but none of them are relevant to the market today. They are:
To permanently resolve the cash crunch, in response to historical events such as the repo market turmoil in late 2019 and the launch of FIMA during the pandemic crisis in March 2020.
Iterate its own interest rate management framework, introduce a new capped interest rate, enrich its own interest rate corridor.
Establishing itself as the central bank of the world to match the forthcoming us dollar digital currency (CBDC) credits.
First, with SRF, the Fed can avoid the repurchase wave that occurred in late 2019 because counterparties can always borrow from the Fed with TREASURIES and other eligible collateral.
In mid-September 2019, due to a sharp drop in reserves due to the corporate tax period, there was a significant transfer of reserves from the system to the TGA, while net Treasury issuance increased. Causing overnight money market rates in the US to soar and show significant volatility.
But that was against a backdrop of shrinking reserves and the Treasury’s appetite for cash, leaving less and less liquidity in the market for interest rates to break out of the Fed’s range.
The current situation is that the Fed has not yet started to taper QE, reserves are abundant and liquidity ($1 trillion) has poured into the overnight reverse repurchase facility (RRP). At one point in the first half of the year, money market rates were almost below zero.
Look at financial side, the market in August for the Treasury to refinance is expected to cut issuance, because the outbreak has gradually in the past, the fewer the fiscal spending, a spending bill size reduction will be a reduction, yellen also working to tax revenue, and therefore, the rebalancing of the fiscal deficit has makes Treasury of liquidity of the siphon effect weakened.
Isn’t it an inopportune time to provide a standing tool that can be called upon to create liquidity at any time during a flood of liquidity? Everyone has 5 BPS /10 BPS in their ONRPPs and reserve accounts, is anyone going to ask the Fed to borrow money for 25 BPS?
The same is true with the establishment of SFIMA. At present, the US Treasury market has not experienced the dramatic fluctuations of the outbreak, and the current use of US dollar liquidity swaps and FIMA is only a few hundred million dollars. To suddenly provide a single counterparty liquidity facility with a cap of $60bn would be too abrupt…
Yes, but you don’t have to.
Let’s talk about the second meaning.
The fed set the facility rate at 0.25%, the top of its current range.
And that makes sense, because in the previous framework of interest rate management, the Fed used the Floor System. Just to explain the system briefly.
The interest rate floor system, which provides a guaranteed rate for different market counterparties, allows the Fed to absorb funds on its balance-sheet through ONRRP (overnight reverse repurchase rate) in order to avoid excess liquidity in the market, where money has nowhere to invest.
For example, the current adjusted ONRRP is 5bps. Then the repo rate (SOFR) in the market would not fall below 5 BPS, because no fool would do that. Instead, he would put his money in ONRRP and eat 5 BPS.
In turn, the 25bps of SRF makes sense.
The SRF acts as an interest rate ceiling, meaning a ceiling rate for different market counterparties, because you can’t borrow at 30 basis points in the market when you can ask the Fed to borrow at 25 basis points.
SRF and SFIMA make it difficult for market rates to break the upper edge of their managed range, because counterparties can ask the Fed to create enough liquidity out of thin air at the upper cost. Unless the liquidity needs of the market exceed the upper limit of what SRF and SFIMA can provide.
ONRRP makes it harder for market rates to break the lower edge of the managed rate range, where counterparties can deposit enough liquidity. Unless excess liquidity in the market exceeds the upper limit for the use of ONRRP.
SRF and SFIMA did make the Fed’s rate-management framework more symmetrical.
In the event of a liquidity crisis in the banking system, banks can access liquidity through the Fed’s SRF and discount window facilities.
If dealers’ liquidity deteriorates due to overissuance, primary dealers can finance Treasury inventories at any time through the Fed’s SRF.
In case of a shortage of overseas dollar liquidity caused by an unexpected event, foreign central banks can convert their holdings of US treasuries into DOLLAR liquidity at any time through the FED’s SFIMA without selling.
SRF and SFIMA are necessary as part of the interest rate framework, but still seem a bit out of place at the moment.
Why is that? Because nobody wants money now… The control of the interest rate ceiling is usually considered during the period of tightening. Now even the Taper Taper has not started, and the rate increase and the contraction of the balance sheet are not in sight. Why the rush to SRF and SFIMA?
The third meaning is even less clear. It’s symbolic.
Overall, I think SRF and SFIMA are good tools and do enrich the Fed’s interest rate corridor system. But, at this point, few people will care.
In addition, there are some technical benefits associated with a potential overhaul of the monetary policy framework, but this may not work out if it continues to unfold.
In short, when you can turn long-dated assets into liquidity (reserves/deposits) at the Fed at any time, the need to hold reserves decreases. Then when it comes time to shrink the balance sheet, everyone will be less nervous, because banks and primary dealers can always expand their balance sheets through SRF.
If the Fed moves to the reserve-scarcity framework of the pre-2008 crisis, it is a different story.
The downside is that while the tools are being used, the Fed’s balance sheet is being passively expanded, and the most collateral is Us Treasuries, so there is a sense of being held hostage by the Treasury. But… Who says it’s not now?
SRF and SFIMA make no sense at this stage of the market and will not affect your asset allocation.
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