The sole key risk event on today’s rather short calendar is the release of the FOMC minutes at 20:00 CET. Therefore, today’s Comment is dedicated solely to the Fed’s balance sheet and money market troubles and what should be done to solve them. While Fed Chair Powell kind of gave the game away when he said last night that the Fed will probably soon start buying Treasury bills to boost reserves, we still believe it’s worthwhile to offer a technical explanation of last month’s turmoil.
Recall that in September the Fed cut its benchmark interest rate, the interest rate it pays on banks’ excess reserves, by 30bps to 1.80. The rate cut took place just when the Fed had lost control of money market rates. Repo rates were blasting higher, which in turn resulted in strong upward pressure on the fed funds rate. On September 17, a day before the FOMC statement was issued, fed funds settled at 2.30, 20bps higher than what the Fed pays banks on excess reserves and 5bps above the upper bound of the target range for the federal funds rate. The spread on September 17 between fed funds and the interest on excess reserves rate (IOER rate) was the widest under the Fed’s ‘ample reserves’ system of managing money market rates. Ample reserves because there were still $1.3 trillion in excess reserves on banks’ balance sheet.
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