The Fed’s Newest Option

In October, short treasuries were whipsawed by political dysfunction with the threat of an “operational interruption” to Treasury bills that caused yields to soar above 50 basis points for October 17 maturities. This volatility followed on the heels of a Treasury rally in September which was induced by the Fed’s failure to announce a tapering of asset purchases at its last FOMC meeting. Looking through all of this noise to the fundamentals, the Fed continues to downwardly adjust its GDP forecasts from overly optimistic levels and core inflation reports have been steadily below the Fed’s predictions. This reality increases the probability of continued quantitative easing as Janet Yellen likely takes the helm of the Fed in January. If confirmed, Ms. Yellen will inherit a vastly complex challenge, and balance sheet, along with the heightened potential for unintended policy consequences as the Fed plots an eventual unwind of the unconventional policies of the last several years.

Control of the yield curve, given the volatility of late, will remain one of the biggest challenges for the Fed. To that end, the Fed has developed new tools that should give them greater control than in past cycles. While security purchases or tapering of those purchases provides the Fed influence over the long end of the curve, the Fed’s new Overnight Reverse Repo facility offers precise control of short rates as well as provides potential benefits to the money markets. With this new program comes the hope that the trend of shrinking supply of short-term, high-quality liquid assets, which we wrote about in January, can be reversed. While still in its infancy, we think if this program is expanded it may have a huge impact on the supply and, thus, yield of securities on the short end of the curve. So, this month we penned a research summary of the Fed’s new Overnight Reverse Repo facility and its potential impact on the money markets and Fed policy.

DOWNLOAD FULL REPORT

Best Regards,

Ben Campbell
President & CEO