The rate the Fed pays on the reverse repo window is 3.05%. It has even been below 3%, which is not a great look as the fed funds floor is 3%. Such is the size of that excess that the SOFR rate, effectively the general collateral rate, has been dragged down to the 3% area at times. There is a running US$2.2tr going back to the Fed on the overnight reverse repo facility, reflective of an ongoing excess of liquidity in the system. The other issue that will be interesting for the Federal Reserve is whether it decides to talk about market technicals. That’s where the direction for the 10yr yield will come from.
And if not, whether it over or undershoots the 100bp discounted. The issue for the 10yr is whether that 100bp gets delivered. That’s still some 100bp below where the market expects the effective fund rate to get to. And if the Fed hikes by 75bp on 2 November, the effective funds rate will move up to 3.83%. In the past week, that market discount has moved from 5% down to 4.8%. The market discount for the terminal fed funds rate is very important for the trajectory of the 10yr Treasury yield. The 10yr effect, market liquidity and Fed cost management Consequently, we do indeed expect the Fed to open the door to a slower pace through formal forward guidance, but it may not necessarily go through it. The speed with which Treasury yields, mortgage rates and other borrowing costs have been rising in the economy is causing some economic stress, most notably in the housing market, but there is also concern that financial stresses could potentially be brewing in the system.
Smaller rate hikes from Canada and Australia have added to a sense that bankers are looking to tone down the aggressiveness.Īs Fed chair Jerome Powell has repeatedly admitted, monetary policy works with “long and varied lags” and after having hiked rates 375bp, it might soon be time to stop battering the economy so aggressively. This was followed by comments from San Francisco Fed president Mary Daly, echoing sentiments from Fed governor Chris Waller that the Fed is "thinking about a step down, but we’re not there yet". His article hinted that some officials are concerned that things were moving too fast too quickly and they need to rein the market back a bit, which has re-opened the possibility of “just” a 50bp hike in December. However, a Wall Street Journal article last Friday by Nick Timiraos, who has gained a reputation as the Fed's go-to guy when "senior management" want to guide the market more directly, helped alter the balance of thinking. The market had been favouring a fifth consecutive 75bp hike at the December FOMC meeting up until late last week.
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