A number of clients have requested our thoughts on the Fed’s reserve management going forward. They will, with the first settlement today, buy $60bn in Treasury Bills every month concentrating on Bills maturing out to a one year term into at least Q2’20. The Fed announced this on October 11th adding; ‘to mitigate the risk of money market pressures that could adversely affect policy implementation’. In addition, they will offer daily overnight and twice-weekly term repo operations through to January 2020. The timing of the announcement caught many off guard but it appears the Fed were very conscious of trying to separate the balance sheet management from the interest rate decision at their 30th October meeting.
The reasons for this can be seen back in September when we had pressures in the dollar funding rate due to the constant demand for US dollars. Rates over a three day period hit over 10% in the repo market a couple of times as it appears banks were caught short at the same time as a corporate tax payment date. The Fed acted swiftly through the repo market to supply additional funds, the first time in over a decade, and push rates down to the funds target range but it did appear as though the Fed were caught out by the huge demand. Of course such volatility is dangerous in the short-end of the market as it could cause serious dislocations in the system. We believe the Fed has enacted enough measures to curtail this volatility but the real pressures won’t appear until we get into year-end when historically short-rate volatility has been a factor.
If the Fed is truly reliant on data dependance for their rate policy, Retail Sales yesterday was a big miss, coming in at -0.3%mom in September versus +0.3% expectations. The chances of a further cut in the funds rate this month has jumped and now looks an odds on bet in the bookies with the market at 85.3% for 25bps.