Short-Term Money Market Monitoring. Internal FR

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1 Short-Term Money Market Monitoring Internal FR

2 Agenda Basics of U.S. Money Markets Markets Group Coverage of U.S. Money Markets Key Developments in U.S. Money Markets 2

3 Basics of U.S. Money Markets for internal use only

4 Introduction What are Money Markets? Wholesale market for low-risk, highly liquid, short-term IOUs Why do We Care About Money Markets? Financial Intermediaries, U.S. Government, and others use money markets to finance their debt Lenders use money markets to earn incremental return on cash positions Federal Reserve implements monetary policy through money markets 4

5 How are U.S. Money Markets Structured? Two Distinct Segments 1. Unsecured Markets: short-term loans that are not collateralized Federal Funds Eurodollars Commercial Paper Certificates of Deposit 2. Secured Markets: short-term loans that are collateralized Repurchase Agreements General Collateral Specials 5

6 Federal Funds Definition: Unsecured loans of reserve balances at Federal Reserve Banks of eligible institutions % 0.75 Effective Fed Funds Rate (EFFR) Interest on Excess Reserves (IOER) ON RRP Offering Rate (ON RRP) Size: $50 to $80 billion 0.50 Main Tenors: Overnight and term 0.25 Main Borrowers: Banks /15 4/15 7/15 10/15 1/16 4/16 Source: FRBNY Main Lenders: Federal Home Loan Banks What Drives Market Rates? Given the substantial amount of excess reserves, banks mainly borrow because they can earn a spread (arb.) between fed funds and IOER FHLBs lend in fed funds as they can not earn IOER on Fed deposits Federal Reserve targets a range for fed funds to trade within 6

7 Eurodollars Definition: Unsecured U.S. dollar deposits held at banks or bank branches outside of the U.S. Size: >$200 billion % EFFR Volume-Weighted Median Eurodollar Rate (Eurodollar) IOER ON RRP Main Tenors: Overnight and term 0.25 Main Borrowers: Banks 0 10/15 11/15 12/15 1/16 2/16 Source: FRBNY, FR 2420 Main Lenders: Prime money market mutual funds (MMFs), corporates, foreign central banks, etc. What Drives Market Rates? Market rates similar to fed funds as banks can substitute between the two to conduct arb. trades with IOER 7

8 Commercial Paper Definition: Unsecured, short-term debt issued by corporates % Month AA Financial CP 3-Month Libor 3-Month OIS Size: ~$1 trillion 0.50 Tenors: Overnight to 270 days 0.25 Main Borrowers: Banks, corporates /15 4/15 7/15 10/15 1/16 Source: FRBNY Main Lenders: Prime MMFs, corporates, insurance companies, etc. What Drives Market Rates? Borrowers use CP to meet core funding needs Cash lender demand for credit products 8

9 Funding Indicators Spread Between Term Interbank and Basis Points Expected Federal Funds Rates FX Swaps ECB 3- year LTROs Cyprus bail-out U.S. Govt Shutdown Spot* Forward** *3-month LIBOR less 3-month overnight index swap (OIS); ** 3-month Forward Rate Agreement (FRA) less 3-month OIS three months forward (3x6 FRA-OIS spread) Source: Bloomberg Basis Points Cross-Currency Swap Basis* 3-Month EUR/USD 3-Month USD/JPY * Sign of change inverted so widening indicates higher cost of swapping currencies to USD. Source: Bloomberg LIBOR-OIS: spread between LIBOR and the Overnight Indexed Swap (OIS). Used to quantify stress in the interbank market, removes policy rate component from LIBOR, and therefore represents counterparty credit risk FRA-OIS: Gives market expectations for LIBOR-OIS FX Swap Basis: The basis is the premium paid by international institutions to obtain dollars in the FX swap market 9

Repurchase Agreements (Repo) Definition: An agreement between two parties which one sells a security with an agreement to repurchase the security at a specified price and future date Size of the

10 Repurchase Agreements (Repo) Definition: An agreement between two parties which one sells a security with an agreement to repurchase the security at a specified price and future date Size of the Market: ~ $2 to $3 trillion (2/3s Tri-Party, 1/3 Bilateral) Market Participants use repo to finance OMO-eligible (e.g. Treasuries) and non-traditional (e.g. equites) collateral Security dealers act as intermediaries between cash borrowers and lenders Cash Borrowers: Hedge funds, dealers, REITs, etc. Cash Lenders: MMFs, GSEs, sec. lenders, etc. 10

11 Overnight Treasury Repo Market Treasury collateral can be financed in the specials repo market or general collateral (GC) repo market % Treasury Tri-Party ex. GCF Rate* (TPR ex. GCF) Treasury GCF Repo Index (GCF) IOER ON RRP Most treasury GC repo financed via the tri-party repo settlement platform 0.25 Overnight Treasury GC repo rates are highly dependent on calendar dates and collateral settlement dynamics 0 1/15 4/15 7/15 10/15 1/16 4/16 *used the BNYM Repo Index, includes Fed transactions Source: FRBNY, Bloomberg, BNYM Interdealer repo rates (GCF) trade above client repo rates (tri-party ex. GCF/BNYM Index) 11

12 Temporary Open Market Operations (TOMOs) The Federal Reserve conducts TOMOs to assist in targeting the effective fed funds rate. Since the crisis, the look of TOMOs has changed Pre-Crisis TOMOs: Desk would conduct RPs and RRPs to fine-tune the level of reserves in the system to target the fed funds rate Current TOMOs: Desk conducts daily ON RRP operations to support IOER in maintaining control of the fed funds rate 12

13 Markets Group Coverage of U.S. Money Markets for internal use only

14 Money Market Staff Structure Trader/Analyst Role Money Market Participant Coverage Secured Money Market Coverage Temp. Open Market Operations (TOMOs) Unsecured Money Market Coverage 14

15 How We Monitor Money Markets Resources for Money Market Monitoring Public Data Resources (i.e. Bloomberg) Outreach to Money Market Participants (Primary Dealers, RRP Counterparties, Government Sponsored Enterprises) Transaction Level Data (i.e. FR 2420) 15

16 Questions We Seek to Answer? Main Questions: How effective is the Federal Reserve s monetary control of short-term interest rates? Other Key Questions: Relationship between cash borrowers and cash lenders and how it impacts money market rates? Impact of regulations? Signs of funding stress? 16

17 Key Developments in U.S. Money Markets for internal use only

18 Fed Maintains Rate Control Post-Liftoff Following the December FOMC decision to raise the target range, money market rates shifted upwards in tandem with the target range % EFFR TPR ex. GCF* IOER 1M Treasury Bill Eurodollar GCF ON RRP Average daily money market volumes were stable through liftoff The higher target range did not result in higher RRP take-up, and the Fed has maintained monetary control even as RRP take-up fell to record lows in 2016 Overall, liftoff went smoothly and did not result in any structural changes in money markets /15 12/15 1/16 2/16 *used the BNYM Repo Index, includes Fed transactions Source: FRBNY $ bln ON RRP Take-Up December FOMC 0 11/15 12/15 1/16 2/16 Source: FRBNY 18

19 Impact of Basel III Regulations % Overnight Unsecured and Secured Rates EFFR Eurodollar TPR ex. GCF* GCF IOER ON RRP 2016 year-end $ bln Overnight Unsecured and Secured Volumes Eurodollars Federal Funds Treasury Repo* RRP Demand 2016 yearend /15 1/16 2/16 *used the BNYM Repo Index, includes Fed transactions Source: FRBNY, FR 2420, Bloomberg, BNYM 0 12/15 1/16 2/16 *Includes tri-party GC and GCF volumes Source: FRBNY, FR 2420, Bloomberg, BNYM, JPMC Banks and dealers cite the Basel III Leverage ratio as reducing the attractiveness of low-margin, balance sheet intensive trades, such as matched-book repo and the IOER arb. On quarter-ends, foreign banks and dealers reduce the size of their balance sheets causing unsecured rates to decline, secured rates to increase, and RRP take-up to surge 19

20 Money Market Fund (MMF) Reform In July 2014, the SEC voted to adopt further amendments to Rule 2a-7, which governs MMFs. The reforms were designed, in part, to reduce MMFs susceptibility to destabilizing runs by investors As a result, by October 2016, institutional prime MMFs will be required to have floating NAVs and, under certain conditions, be able to impose liquidity fees or redemption gates Since MMF shareholders have strong preference for stable NAV and aversion to fees and gates Multiple Prime MMFs have converted to Gov. MMFs, with more expected MMF shareholders are expected to switch investments from Prime MMFs to Gov. MMFs Higher Gov. MMF AUMs equates to greater demand for short-term government assets and downward pressure on money market rates 20

21 Money Market Outlook Future conundrum Federal Reserve s controlling of short-term rates Reduced supply of private short-term government assets due to regulations + Increased demand for private short-term government assets due to regulations/reform = lower short-term money market rates Possible remedies? Treasury is targeting a higher cash balance, which has increased the amount of Treasury bills outstanding and, thus, the supply of short-term government assets ON RRP is currently uncapped and limited only by the amount of Treasury collateral in the SOMA portfolio; however, FOMC states this is temporary 21

Introduction to Fixed Income (IFI) Course Syllabus

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