After reading and rereading the minutes, my sense is that the Fed may be battling a series of dilemmas. Many issues for them to ponder: Maintaining control over short-term rates, the eventual size and end of its balance sheet unwind, the ever-flattening yield curve, and inflation.
Market participants caught off-guard by the inclusion of the IOER realignment discussion. Bit of short-covering in fed funds futures (up 2.5 to 7 basis points) and June 2018 eurodollar futures (up 6 basis points).
By narrowing the spread between the RRP rate and IOER, the fed may be trying to force banks to part with their excess reserves by disincentivizing banks from partaking in anymore Fed arbitrage trades.
Another x-factor for the narrowing IOER/fed funds spread: Once the FDIC's insurance premium for U.S. banks (estimated to be 4-8 bp) is eliminated by the end of 2018, it's expected to put upward pressure on the fed funds rate, possibly causing to trade in line with IOER.
It would behoove FOMC participants to take a look at Randy Quarles's May 4 speech on the Fed's balance sheet as he talks about one of the biggest x-factors for reserves and interest rates: the liquidity coverage ratio.
The irony about the Fed trying to keep IOER (Interest on Excess Reserves) as the ceiling of its target range is that the rate was always intended to be a floor.
While it's easy to peg the rise in short-term funding rates on the $330 billion of Treasury bill supply issued in February and March, there have been other issues pressuring the market. Repatriation concerns related to the U.S. tax overhaul, and reserve draining related to the Fed's balance sheet unwind also come to mind.
Fed funds futures market is currently pricing in fewer than two more rate increases for the rest of 2018; odds of an increase at the June meeting are roughly 80%
"Flattened a bit" is an understatement when talking about the yield curves. In between January and March meetings, the 2/10 curve has flattened by about 23 basis points and touched the lowest levels since 2007 last week. The 5/30 curve is now at 38 basis points, the lowest level since August 2008.
On March 12, usage at the Fed's facility totaled $1.77 billion, the lowest since November 2013. Scott Skyrm, managing director at Wedbush Securities said Tuesday, the weak usage raises questions as to whether the facility ``is still relevant.''
I wonder what the Fed defines as "notable" when talking about the effect of balance sheet reduction on markets. Declining excess reserves is merely one factor contributing to the narrowing spread between fed funds and interest on excess reserves (the norm has been roughly 8-9 basis points). BofA sees a 6-7 basis point spread as the norm and expects it to narrow to 4-5 basis points by year-end.
I'm now referring to Libor as, "that rate which shall not be named," as Fed officials seemed to do everything in their power to talk around the bedeviled benchmark rate. Only one mention for a rate that has risen roughly 65 basis points since the beginning of the year.
The discussion plays right into Larry Summers' concerns about so-called secular stagnation and the justification of a lower neutral rate. In this case, it's almost as if FOMC participants are trying to rationalize to themselves that there's a limit to where the fed effective rate should be.
Overall, these minutes don't change the markets' outlook on future rate hikes. Fed funds futures are showing 92% odds of a hike by March and have priced in two rate increases by September.
It'll be interesting to see how FOMC members assess the steepening of the yield curves at the March FOMC meeting. Will they attribute it to the government's late-cycle spending spree or pat themselves on the back for the efficacy of monetary policy