Frisky Fed Hike-o-Matic
We haven’t commented on central bank policy for a while, mainly because it threatened to become repetitive; there just didn’t seem anything new to say. Things have recently changed a bit though. A little over a week ago we received an email from Brian Dowd of Focus Economics, who asked if we would care to comment on the efforts by the Fed and the ECB to exit unconventional monetary policy and whether they could do so without triggering upheaval in the markets and the economy**, so we are taking this opportunity to do just that.
Outside view of a famous crime scene: the building where the central planners of the fiat money regime gather to “steer” the economy.
First of all, the FOMC appears to have decided it will no longer be deterred by short term weakness in economic data and continue to implement its rate hike plans anyway. As we have pointed out several times, these baby step hikes in the federal funds rate (modeled after Bernanke’s pre-crash rate hike campaign in 2004-2007) are in some sense atually meaningless.
That is mainly due to the fact that interbank lending of reserves is essentially dead, as banks continue to hold massive excess reserves as a result of QE. The FF rate is therefore no longer really a “monetary policy tool”, since the traditional method of keeping it on target by adding or draining reserves has become moot. The only way to keep the federal funds rate within the Fed’s target corridor (note they use a range these days instead of a precise target rate) is to pay interest on reserves (IOR).
So IOR is actually the most important policy rate in the US. As long as it is kept a the upper end of the FF rate range, commercial banks have no incentive to use their excess reserves as the basis for credit creation of Weimaresque proportions (there are other disincentives to this as well, which range from more stringent capital adequacy requirements to common sense; the latter undoubtedly remains a scarce commodity).
Interest paid on excess reserves vs. the federal funds rate (the former allows the target range of the latter to be maintained despite the enormous amount of excess reserves maintained at the Fed) – click to enlarge.
Another point worth mentioning in the context of the FF rate is that although there is a feedback loop between gross market rates and Fed activity, most of the time the Fed is simply following the lead of the t-bill rate. That is fairly obvious when looking at a comparison chart. Every rate hike in the current cycle was preceded by a surge in the three month t-bill discount rate from below to above the effective FF rate.
Fed rate hikes have followed moves in the t-bill rate. The latter is of course partly driven by expectations about coming rate hikes, so the chicken and egg question is not definitively answered by this chart – …read more
Source:: Acting Man
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