Tag Archives: TAF

Plosser the hawk on the tape

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This is the most hawkish Fed pres:

GLADWYNE, PENNSYLVANIA (Thomson Financial) – The head of the Philly Fed, Charles Plosser, today raised the possibility of a stagflation threat to the US economy.

“Although I am expecting slow economic growth for several quarters, we should not rely on slow growth to reduce inflation,” the Philadelphia Federal Reserve Bank president warned in a speech here. “Indeed, the 1970s should be a sufficient reminder that slow growth and falling inflation do not necessarily go hand in hand.” Plosser, who has a vote on the rate-setting Federal Open Market Committee this year, warned that he is getting increasingly worried about inflation. “Recent data suggest that inflation is becoming more broad-based,” he said, “And recent increases do not appear to be solely related to the rise in energy prices. Consequently I see more worrisome signs of underlying price pressures.” Plosser also used today’s speech to draw a clear line between what the Fed should do to stabilize the economy and what it should do to stabilize financial markets.

He believes the Fed’s three rate cuts will take time to work through the economy and that in the meantime growth will slow.

“Since monetary policy’s effects on the economy occur with a lag, there is little monetary policy can do today to change economic activity in the first half of 2008.” In the meantime, “we will get some bad economic numbers from various sectors of the economy in the coming months,” he added.

But beyond the immediate short term, Plosser was more optimistic. He reckons the economy will “improve appreciably by the third and fourth quarters of 2008, and that is when any monetary policy action today will begin to have noticeable effects.” On the credit market front, the Fed’s new Term Auction Facility (TAF) program should help stabilize financial markets and provide liquidity when the interbank lending markets “are under stress and not functioning smoothly,” he added.

Plosser said early evidence suggests the first two 20 bln usd auctions were successful. Two more have been scheduled later this month.

The key point, he said, is that “the TAF did not change the stance of monetary policy. The Fed actually withdrew funds through open market operations as it injected term liquidity through the TAF.” Plosser was already known as one of the inflation “hawks” among the regional Fed bank presidents. His analysis confirms a preference for avoiding further rate cuts and the risk of further inflation as long as financial markets problems do not pose a danger to the rest of the economy.

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The subprime mess

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On Jan 5, 2008 9:40 PM, Steve Martyak wrote:
> http://www.autodogmatic.com/index.php/sst/2007/02/02/subprime_credit_crunch_could_trigger_col
>
>
> also….
>
> 9/4/2006
> Cover of Business Week: How Toxic Is Your Mortgage? :.
>
> The option ARM is “like the neutron bomb,” says George McCarthy, a housing
> economist at New York’s Ford Foundation. “It’s going to kill all the people
> but leave the houses standing.”
>
> Some people saw it all coming….
>

The subprime setback actually hit about 18 months ago. Investors stopped funding new loans, and would be buyers were were no longer able to buy, thereby reducing demand. Housing fell and has been down for a long time. There are signs it bottomed October/November but maybe not.

I wrote about it then as well, and have been forecasting the slowdown since I noted the fed’s financial obligations ratio was at levels in March 2006 that indicated the credit expansion had to slow as private debt would not be able to increase sufficiently to sustain former levels of GDP growth. And that the reason was the tailwind from the 2003 federal deficits was winding down. as the deficit fell below 2% of GDP, and it was no longer enough to support the credit structure.

Also, while pension funds were still adding to demand with their commodity allocations, that had stopped accelerating as well and
wouldn’t be as strong a factor.

Lastly, I noted exports should pick up some, but I didn’t think enough to sustain growth.

I underestimated export strength, and while GDP hasn’t been stellar as before, it’s been a bit higher than i expected as exports boomed.

That was my first ‘major theme’ – slowing demand.

The second major theme was rising prices – Saudis acting the swing producer and setting price. This was interrupted when Goldman changed their commodity index in aug 06 triggering a massive liquidation as pension funds rebalanced, and oil prices fell from near 80 to about 50, pushed down a second time at year end by Goldman (and AIG as well this time) doing it again. As the liquidation subsided the Saudis were again in control and prices have marched up ever since, and with Putin gaining control of Russian pricing we now have to ‘price setters’ who can act a swing producers and simply set price at any level they want as long as net demand holds up. So far demand has been more than holding up, so it doesn’t seem we are anywhere near the limits of how high they can hike prices.

Saudi production for December should be out tomorrow. It indicates how much demand there is at current prices. If it’s up that means they have lots of room to hike prices further. Only if their production falls are they in danger of losing control on the downside. And I estimate it would have to fall below 7 million bpd for that to happen. It has been running closer to 9 million.

What I have missed is the fed’s response to all this.

I thought the inflation trend would keep them from cutting, as they had previously been strict adherents to the notion that price
stability is a necessary condition for optimal employment and growth.

This is how they fulfilled their ‘dual mandate’ of full employment and price stability, as dictated by ‘law’ and as per their regular reports to congress.

The theory is that if the fed acts to keep inflation low and stable markets will function to optimize employment and growth, and keep long term interest rates low.

What happened back in September is they became preoccupied with ‘market functioning’ which they see as a necessary condition for low inflation to be translated into optimal employment and growth.

What was revealed was the FOMC’s lack of understanding of not only market functioning outside of the fed, but a lack of understanding of their own monetary operations, reserve accounting, and the operation of their member bank interbank markets and pricing mechanisms.

In short, the Fed still isn’t fully aware that ‘it’s about price (interest rates), not quantity (‘money supply, whatever that may be)’.

(Note they are still limiting the size of the TAF operation using an auction methodology rather than simply setting a yield and letting quantity float)

The first clue to this knowledge shortfall was the 2003 change to put the discount rate higher than the fed funds rate, and make the discount rate a ‘penalty rate.’ This made no sense at all, as i wrote back then.

The discount rate is not and can not be a source of ‘market discipline’ and all the change did was create an ‘unstable equilibrium’ condition in the fed funds market. (They can’t keep the system ‘net borrowed’ as before) it all works fine during ‘normal’ periods but when the tree is shaken the NY Fed has it’s hands full keeping the funds rate on target, as we’ve seen for the last 6 months
or so.

While much of this FOMC wasn’t around in 2002-2003, several members were.

Back to September 2007. The FOMC was concerned enough about ‘market functioning’ to act, They saw credit spreads widening, and in particular the fed funds/libor spread was troubling as it indicated their own member banks were pricing each other’s risk at higher levels than the FOMC wanted. If they had a clear, working knowledge of monetary ops and reserve accounting, they would have recognized that either the discount window could be ‘opened’ by cutting the rate to the fed funds rate, removing the ‘stigma’ of using it, and expanding the eligible collateral. (Alternatively, the current TAF is functionally the same thing, and could have been implemented in September as well.)

Instead, they cut the fed funds rate 50 bp, and left the discount rate above it, along with the stigma. and this did little or nothing for the FF/LIBOR spread and for market functioning in general.

This was followed by two more 25 cuts and libor was still trading at 9% over year end until they finally came up with the TAF which immediately brought ff/libor down. It didn’t come all the way down to where the fed wanted it because the limited the size of the TAFs to $20 billion, again hard evidence of a shortfall in their understanding of monetary ops.

Simple textbook analysis shows it’s about price and not quantity. Charles Goodhart has over 65 volumes to read on this, and the first half of Basil Moore’s 1988 ‘Horizontalists and Verticalsists’ is a good review as well.

The ECB’s actions indicate they understand it. Their ‘TAF’ operation set the interest rate and let the banks do all they wanted, and over 500 billion euro cleared that day. And, of course- goes without saying- none of the ‘quantity needles’ moved at all.

In fact, some in the financial press have been noting that with all the ‘pumping in of liquidity’ around the world various monetary
aggregates have generally remained as before.

Rather than go into more detail about monetary ops, and why the CB’s have no effect on quantities, suffice to say for this post that the Fed still doesn’t get it, but maybe they are getting closer.

So back to the point.

Major themes are:

  • Weakness due to low govt budget deficit
  • Inflation due to monopolists/price setters hiking price

And more recently, the Fed cutting interest rates due to ‘market functioning’ in a mistaken notion that ff cuts would address that issue, followed by the TAF which did address the issue. The latest announced tafs are to be 30 billion, up from 20, but still short of the understanding that it’s about price, not quantity.

The last four months have also given the markets the impression that the Fed in actual fact cares not at all about inflation, and will only talk about it, but at the end of the day will act to support growth and employment.

Markets acknowledge that market functioning has been substantially improved, with risk repriced at wider spreads.

However, GDP prospects remain subdued, with a rising number of economists raising the odds of negative real growth.

While this has been the forecast for several quarters, and so far each quarter has seen substantial upward revisions from the initial forecasts, nonetheless the lower forecasts for Q1 have to be taken seriously, as that’s all we have.

I am in the dwindling camp that the Fed does care about inflation, and particularly the risk of inflation expectations elevating which would be considered the ultimate Central Bank blunder. All you hear from FOMC members is ‘yes, we let that happen in the 70’s, and we’re not going to let that happen again’.

And once ‘markets are functioning’ low inflation can again be translated via market forces into optimal employment and growth, thereby meeting the dual mandate.

i can’t even imagine a Fed chairman addressing congress with the reverse – ‘by keeping the economy at full employment market forces will keep inflation and long term interest rates low’.

Congress does not want inflation. Inflation will cost them their jobs. Voters hate inflation. They call it the govt robbing their
savings. Govt confiscation of their wealth. They start looking to the Ron Paul’s who advocate return to the gold standard.

That’s why low inflation is in the Fed’s mandate.

And the Fed also knows they are facing a triple negative supply shock of fuel, food, and import prices/weak $.

While they can’t control fuel prices, what they see there job as is keeping it all a relative value story and not ‘monetizing it into an
inflation story’ which means to them not accommodating it with low real rates that elevate inflation expectations, followed by
accelerating inflation.

There is no other way to see if based on their models. Deep down all their models are relative value models, with no source of the ‘price level.’ ‘Money’ is a numeraire that expresses the relative values. The current price level is there as a consequence of history, and will stay at that level only if ‘inflation expectations are well anchored.’ The ‘expectations operator’ is the only source of the price level in their models.

(See ‘Mandatory Readings‘ for how it all actually works.)

They also know that food/fuel prices are a leading cause of elevated inflation expectations.

In their world, this means that if demand is high enough to drive up CPI it’s simply too high and they need to not accommodate it with low real rates, but instead lean against that wind with higher real rates, or risk letting the inflation cat out of the bag and face a long, expensive, multi year battle to get it back in.

They knew this at the Sept 18 meeting when they cut 50, and twice after that with the following 25 cuts, all as ‘insurance to forestall’ the possible shutdown of ‘market functioning’.

And they knew and saw the price of this insurance – falling dollar, rising food, fuel, and import prices, and CPI soaring past 4% year over year.

To me these cuts in the face of the negative supply shocks define the level of fear, uncertainty, and panic of the FOMC.

It’s perhaps something like the fear felt by a new pilot accidentally flying into a thunderstorm in his first flight in an unfamiliar plane without an instructor or a manual.

The FOCM feared a total collapse of the financial structure. The possibility GDP going to 0 as the economy ‘froze.’ Better to do
something to buy some time, pay whatever inflation price that may follow, than do nothing.

The attitude has been there are two issues- recession due to market failure and inflation.

The response has been to address the ‘crisis’ first, then regroup and address the inflation issue.

And hopefully inflation expectations are well enough anchored to avoid disaster on the inflation front.

So now with the TAF’s ‘working’ (duh…) and market functions restored (even commercial paper is expanding again) the question is what they will do next.

They may decide markets are still too fragile to risk not cutting, as priced in by Feb fed funds futures, and risk a relapse into market dysfunction. Recent history suggests that’s what they would do if the Jan meeting were today.

But it isn’t today, and a lot of data will come out in the next few weeks. Both market functioning data and economic data.

Yes, the economy may weaken, and may go into recession, but with inflation on the rise, that’s the ‘non inflationary speed limit’ and the Fed would see cutting rates to support demand as accomplishing nothing for the real economy, but only increasing inflation and risking elevated inflation expectations. The see real growth as supply side constrained, and their job is keeping demand balanced at a non inflationary level.

But that assumes markets continue to function, and the supply side of credit doesn’t shut down and send GDP to zero in a financial panic.

With a good working knowledge of monetary ops and reserve accounting, and banking in general that fear would vanish, as the FOMC would know what indicators to watch and what buttons to push to safely fly the plane.

Without that knowledge another FF cut is a lot more likely.

more later…

warren

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Re: US Libor GC Spreads comment

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(an interoffice email)

Good report, thanks!

On Jan 4, 2008 10:41 AM, Pat Doyle wrote:
>
>
>
> Pre- August 2007 GC US Treasury’s repo averaged Libor less 17 across the
> curve. In early August and again in early December the spread between GC
> and Libor hit it’s wides in excess of 150bps for 3m repo and 180bps for
> 1mos.
>
>
>
> Today’s Spreads:
>
> 1m = L -46.5
>
> 3m = L – 77
>
> 6m = L – 82
>
>
>
> This recent narrowing of the spread is primarily a result of the TAF
> program and CB intervention but may also be attributed to continuing
> writedowns of assets. There is plenty of cash in the short term markets and
> now some of this cash is going out the curve helping to narrow Libor
> spreads. The problem banks continue to have is that their balance sheet size
> and composition is adversely affecting their capital ratios. Banks and
> Dealers remain very cautious about adding risk assets to their balance
> sheets. Bids are defensive as dealers are demanding higher rents (return
> for risk) for balance sheet. Dislocations still exist, for example it may
> make no sense from a credit perspective but AAA CMBS on open repo trades at
> FF’s + 75, while IG Corp trades FF’s + 40, even NON IG Corps trade tighter
> than AAA CMBS. The more assets are either sold or otherwise liquidated off
> of the balance sheets and the more transparent the balance sheet
> compositions become, then the quicker the markets will stabilize
>
>
>
> GRAPH OF 1 MONTH LIBOR VS. 1 MONTH UST GC
>
>

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Saudi/Fed teamwork

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Looks like markets are still trading with the assumption that as the Saudis/Russians hike prices the Fed will accommodate with rate cut.

That’s a pretty good incentive for more Saudi/Russian oil price hikes, as if they needed any!

Likewise, the US is a large exporter of grains and foods.

Those prices are now linked to crude via biofuels.

And the new US energy bill just passed with about $36 billion in subsidies for biofuels to help us keep burning up our food for fuel and keeping their prices linked.

This means cpi will continue to trend higher, and drag core up with it as costs get passed through via a variety of channels. In the early 70’s core didn’t go through 3% until cpi went through 6%, for example.

Ultimately everything is made of food and energy, and margins don’t contract forever with softer demand. In fact, much of the private sector is straight cost plus pricing, and govt is insensitive to ‘demand’ and insensitive to the prices of what it buys. And the US govt. indexes compensation and most transfer payments to (headline) cpi.

And while the US may be able to pay it’s rising oil bill with help from its rising export prices for food, much of the rest of the world is on the wrong end of both and will see its real terms of trade continue to deteriorate. Not to mention the likelihood of increased outright starvation as ultra low income people lose their ability to buy enough calories to stay alive as they compete with the more affluent filling up their tanks.

At the Jan 30 meeting I expect the Fed to be looking at accelerating inflation due to rising food/crude, and an economy muddling through with a q4 gdp forecast of 2-3%. Markets will be functioning, banks getting recapitalized, and while there has been a touch of spillover from Wall st. to Main st. the risk of a sudden, catastrophic collapse has to appear greatly diminished.

They have probably learned that the fed funds cuts did little or nothing for ‘market functioning’ and that the TAF brought ff/libor under control by accepting an expanded collateral list from its member banks.

(In fact, the TAF is functionally equiv of expanding the collateral accepted at the discount window, cutting the rate, and removing the stigma as recommended back in August and several times since.)

And they have to know their all important inflation expectations are at the verge of elevating.

They will know demand is strong enough to be driving up cpi, and the discussion will be the appropriate level of demand and the fed funds rate most likely to sustain non inflationary growth.

Their ‘forward looking’ models probably will still use futures prices, and with the contangos in the grains and energy markets, the forecasts will be for moderating prices. But by Jan 30 they will have seen a full 6 months of such forecasts turn out to be incorrect, and 6 months of futures prices not being reliable indicators of future inflation.

Feb ff futures are currently pricing in another 25 cut, indicating market consensus is the Fed still doesn’t care about inflation. Might be the case!

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Strong gdp and high credit losses

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CNBC just had a session on trying to reconcile high gdp with large credit losses. Seems they are now seeing the consumer clipping along at a +2.8% pace for Q4. No need to rehash my ongoing position that most if not all the losses announced in the last 6 months would have little or no effect on aggregate demand. Credit losses hurt demand when the result is a drop in spending. And yes, that happened big time when the subprime crisis took the bid away from would be subprime buyers who no longer qualified to buy a house. That probably took 1% away from gdp, and the subsequent increase in
exports kept gdp pretty much where it was. But that story has been behind us for over a year.

The Fed is not in a good place. They should now know that the TAF operation should have been done in August to keep libor priced where they wanted it. They should know by now losses per se don’t alter aggregate demand, but only rearrange financial assets. The should know the fall off in subprime buyers was offset by exports.

The problem was the FOMC- as demonstrated by their speeches and actions- did not have an adequate working understanding of monetary operations and reserve accounting back in August, and by limiting the current TAFs to $20 billion it seems they still don’t even understand that it’s about price, and not quantity. Too many members of the FOMC
are mostly likely in a fixed exchange rate paradigm, with its fix exchange rate/gold standard fractional reserve banking system that drove us into the great depression. With fixed exchange rates it’s a ‘loanable funds’ world. Banks are ‘reserve constrained.’ Reserves and consequently ‘money supply’ are issues. Government solvency is an issue.

With today’s floating exchange rate regime none of that is applicable. The causation is ‘loans create deposits AND reserves,’ and bank capital is endogenous. There are no ‘imbalances’ as all current conditions are ‘priced’ in the fx market, including ANY sized trade gap, budget deficit, or rate of inflation.

The recession risk today is from a lack of effective demand. There are lots of ways this can happen- sudden drop in govt spending, sudden tax increase, consumers change ‘savings desires’ and cut back spending, sudden drop in exports, etc.- and in any case the govt can instantly fill in the gap with net spending to sustain demand at any level it desires. Yes, there will be inflation consequences, distribution consequences, but no govt. solvency consequences.

So yes, there is always the possibility of a recession. And domestic demand (without exports) has been moderating as the falling govt budget acts to reduce aggregate demand. But the rearranging of financial assets in this ‘great repricing of risk’ doesn’t necessarily reduce aggregate demand.

Meanwhile, the Saudis, as swing producer, keep raising the price of crude, and so far with no fall off in the demand for their crude at current prices, so they are incented to keep right on hiking. And they may even recognize that by spending their new found revenues on real goods and services (note the new mid east infrastructure projects in progress) they keep the world economy afloat and can keep hiking prices indefinitely.

And food is linked to fuel via biofuels, and as we continue to burn up every larger chunks of our food supply for fuel prices will keep rising.

The $US is probably stable to firm at current levels vs the non commodity currencies, as portfolio shifts have run their course, and these shifts have driven the $ down to levels where there are ‘real buyers’ as evidenced by rapidly growing exports.

Back to the Fed – they have cut 100 bp into the triple negative supply shock of food, crude, and the $/imported prices, due to blind fear of ‘market functioning’ that turned out to need nothing more than an open market operation with expanded acceptable bank collateral (the TAF program). If they had done that immediately (they had more than one outsider and insider recommend it) and fed funds/libor spreads and other ‘financial conditions’ moderated, would they have cut?

There has been no sign of ‘spillover’ into gdp from the great repricing of risk, food and crude have driven their various inflation measures to very uncomfortable levels,and they now believe they have ‘cooked in’ 100 bp of inflationary easing into the economy that works with about a one year lag.

Merry Christmas!

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Repo Mkts and TAF

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(an interoffice email)

On 12/21/07, Pat Doyle
wrote:
>
>
>
> It is becoming apparent that the funding pressures for year end are ebbing.
> The ease in pressure has a lot to do with the TAF and coordinated CBK
> interventions. The Fed is getting the cash to the people who need it.
> Discount window borrowings have been slowly climbing as well approx 4.6bb
> now. The Fed statement that they will provide this TAF facility for as long
> as needed is easing concerns amongst banks and providing a reliable source
> of funding for “hard to fund” assets.

Should have done this in August!
>
>
> There is and has been a lot of cash in the markets still looking for a home.
> Balance sheets are slowly cleaning up but balance sheet premiums (repo) will
> remain stubbornly high as long as the level 3 type assets remain on
> dealer/bank balance sheets.
>
>
>
> The current spread between the 1×4 FRA vs. 1×4 OIS is 57bps..

This looks like a good play – seems unlikely LIBOR will be at a wider spread than the discount rate. Load up the truck?

1×2 FRA vs.
> 1×2 OIS is 40bps. Spot 1mos LIBOR VS 1MOS FFs is 4.86 vs. 4.25 or 61bps.
> These spreads still represent continued unwillingness to lend in the
> interbank market and also illustrate a steeper credit curve.
>
>
>
> Turn funding has not changed substantially. While funding appears to be
> stabilizing, balance sheets are still bloated and capital ratios are still
> under pressure therefore balance sheets will remain expensive in repo land.
>
>
>
> From another bank;
>
> Mortgages over the year-end turn traded at 5.25 today, which we still feel
>
> is a good buy here considering the amount of liquidity the fed has been
> dumping
>
> into the system as of late (via the TAF and standard RP operations) and the
>
> expectation that they will continue to do so on Dec 31. Treasuries also
> traded
>
> over the turn traded today at 2.50, the first treasury turn trade we’ve seen
> in
>
> quite some time.
>
>
>
>
>
> Yesterday Tsy GC O/N’s backed up from the low 3s to 3.70. The FED has been
> actively trying to increase the supply of treasuries in the repo markets.
>
>
>
> AGENCY MBS repo has been steadily improving. 1mos OIS vs 1mos AGCY MBS has
> gone from a spreads of 63bps last week to 15bps last night. And spreads to
> 1month LIBOR have widened by 33bps AGCY MBS from L-23 12/13 to L-56 12/20.
> Again LIBOR still showing the unwillingness of banks to lend to each other.
>
>
> -Pat
>
>
>
>
> Patrick D. Doyle Jr.
>
> AVM, L.P. / III Associates
>
> 777 Yamato Road
>
> Suite 300
>
> Boca Raton, Fl. 33431
>
> 561-544-4575
>
>

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Libor rates & spreads: down in GBP & EUR, stable in US

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Thanks, Dave, my thought are the Fed will also ‘do what it takes’ which means setting price and letting quantity for term funding float.

The ECB doing 500 billion without ‘monetary consequences’ beyond lowering the term rates should have been no surprise to anyone who understands monetary ops, and confirmation of same for those central bankers who may have needed it demonstrated.

Libor rates; no surprises, most of them are down, especially in longer expiries (3mth+) -see table below-. GBP3m -18bp helped by yesterday’s auction. EUR 3m -4.75bp and probably more tomorrow.

Libor spreads.- In 3mth -spot- rates, sharp declines in EUR (-6bp to 78bp) and GBP (-14bp to 76bp) while the US spread remains fairly stable at 80.3bp (-1bp).

It seems the BoE and ECB have taken bolder actions to provide liquidity (see this morning’s message on the ECB LTRO). Let’s see the results of the 1st $20bn TAF later today.

19-Dec
Libor Rate		 18-Dec
Libor Rate		 Change in
% Points		 18-Dec
Libor		 17-Dec
Libor		 Change in
% Points
USD Overnight 4.34500% 4.40000% -0.05500% 4.40000% 4.41750% -0.01750%
USD 1 Week 4.38875% 4.38625% 0.00250% 4.38625% 4.36375% 0.02250%
USD 3 Month 4.91000% 4.92625% -0.01625% 4.92625% 4.94125% -0.01500%
USD 12 Month 4.41750% 4.47188% -0.05438% 4.47188% 4.51875% -0.04687%
EUR Overnight 3.86125% 3.82750% 0.03375% 3.82750% 3.98875% -0.16125%
EUR 1 Week 4.01000% 4.01625% -0.00625% 4.01625% 4.06625% -0.05000%
EUR 3 Month 4.80125% 4.84875% -0.04750% 4.84875% 4.94688% -0.09813%
EUR 12 Month 4.80250% 4.80750% -0.00500% 4.80750% 4.88313% -0.07563%
GBP Overnight 5.58750% 5.59750% -0.01000% 5.59750% 5.59750% 0.00000%
GBP 1 Week 5.61125% 5.63250% -0.02125% 5.63250% 5.64125% -0.00875%
GBP 3 Month 6.20563% 6.38625% -0.18062% 6.38625% 6.43125% -0.04500%
GBP 12 Month 5.88000% 5.94500% -0.06500% 5.94500% 5.96375% -0.01875%

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MBS Repo Markets

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Thanks Pat, good report.

Yes, the Fed knows the assets won’t go away, and all they want is to see funding spreads narrow to help insure the banks aren’t forced to sell due to funding issues and thereby distort prices beyond prudent repricing of risk.

TAF auction (20bb) results announcement will come out tomorrow Wednesday 12/19 at 10:30am. Results of the program have had limited impact on repo rates but have reduced Libor rates by 20bps.Turn levels from Bank of America

UST GC= 2.80 / 2.40

AGCY MBS = 5.15

The problem with funding balance sheets hasn’t disappeared. The TAF and The Treasuries TTL programs have simply reduced the cost of funding but have not, and cannot, make an impact on balance sheet size or composition problems. Balance sheets are bloated with ABCP/ CLO / CDO / Enhanced Cash / Structured ABS / etc….

A quick survey of 4 dealers illustrates how balance sheet pressures and the liquidity of balance sheets have affected the bid for repo collateral. Usually dealers across the maturities dealers are within 5bps of each other. Currently the dispersion of bids is very wide.

At the same time we are finding dealers with balance sheet to lend. It’s just the prices of cash vary by dealer and by term and depend on which banks have bought term liquidity and what term they bought it for.

  1w 1m 3m 6m 9m 1y
MS 4.50 4.75 4.55 4.36   4.15
Citi 4.65 5.20 5.05 4.95 4.70 4.55
CSFB 4.45 4.90 4.80 4.70 4.60  
BoA 4.80 5.10 4.65 4.40 4.30 4.20
Ave 4.60 4.99 4.76 4.60 4.53 4.30
Range 0.35 0.45 0.50 0.59 0.40 0.40

The MBS spreads to LIBOR has narrowed as well. Agcy MBS had been trading as much as L-50 for 3m and longer terms. Now we are close to L-20. This seems to be a result of the TAF and CBK liquidity programs providing cheaper funds along the curve and reflects a relative downward move in LIBOR rates as the MBS and OIS markets are essentially unchanged from a week ago.

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Lender of next-to-last resort?

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There seems to be an alternative to the discount stigma – is the liquidity problem too big for (orthodox) central banks?

The Federal Home Loan Bank System: Lender of Next-to-Last Resort?

Morten Bech, Federal Reserve Bank of New York

When we look at the FHLB balance sheet, we see a $746b surge in net lending to the banking system (at an annualized rate) in Q3. Is it true, then, that banks are suffering from an access to funding? If banks have been shy about tiptoeing to the discount window, they seem to have had no such bashfulness on their way to borrowing or securing advances from FHLB.

How, then, can any Fed official get in front of a microphone with a straight face and say we have a liquidity problem, best addressed by a TAF facility, which at the moment is scheduled to auction off a fraction of that which has already been loaned by FHLB to the banking system?

‘Liquidity’ for fed member banks is about price, not quantity. There is a ‘liquidity problem’ when the term structure of interbank rates isn’t to the fed’s liking.

Currently, the issue seems to be LIBOR – the fed wants the spread over fed funds to be narrower, particularly over year end. The ‘new facility’ should directly address this particular pricing issue.

There is another problem with this injecting liquidity story. If the Fed wishes to maintain the fed funds rate at the current target, assuming the demand curve for reserves remains stable, the Fed will have to remove as many reserves through open market operations as they inject through the TAF.

Yes. Not a problem. The TAF should function exactly that way to narrow spreads above.

If they don’t, the reserves will be in surplus, and the fed funds rate will fall below the target. In fact, the Fed’s balance sheet has been growing relatively slowly, even though they have been easing, especially when compared to the unprecedented expansion of FHLB balance sheet growth.

Yes, again, it’s all about price, not quanity.

The FHLB is acting as a broker – long with some investors/banks/etc and short with others.

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