Fed Raised Rates Without a Hitch, and It Only Took $105 Billion

QuickTake: The Fed Lifts Off
  • Benchmark rate rises 20 basis points to middle of new range
  • Reverse repos drain $105 billion Thursday, $143 billion Friday

The Federal Reserve succeeded in nudging borrowing costs higher Thursday after its first interest-rate increase since 2006, and policy makers only needed to siphon $105 billion from money-market funds to achieve their goal.

QuickTake The Repo Market

Led by Chair Janet Yellen, the Fed lifted the federal funds rate from near zero, where it had been since the financial crisis unfolded in 2008. Thursday, the quarter-point rate boost rippled through money markets that are awash in nearly $3 trillion in excess cash that the Fed injected through bond purchases.

For all the talk of the challenge facing officials as they orchestrate higher rates with so much money sloshing around, Thursday’s market operations weren’t much different in scale than previous days. And the benchmark rate rose 0.2 percentage point, or 20 basis points on Thursday -- practically to the middle of the Fed’s intended range.

The Fed funds effective rate, the average of daily trades, was 0.37 percent on Thursday, according to data posted Friday on the New York Fed’s website. Funds opened Friday at 0.36 percent, according to ICAP Plc, the world’s largest inter-dealer broker.

Trading in the fed funds market went "extremely smoothly," said Bill List, capital markets manager at the Federal Home Loan Bank of Pittsburgh. "The whole fed funds market seemed to adjust with relative ease this morning and everything just set at a higher level."

While the Fed is sticking to the funds rate as its main method of communicating its policy stance, the burden of lifting rates fell elsewhere. That’s because with so much cash in the system, interbank lending has fallen almost 90 percent since 2008.

This time, the Fed turned to the repurchase -- or repo -- market to tighten policy. The central bank conducted its first post-liftoff overnight borrowing operation in that market Thursday afternoon.

The Fed drained $105 billion Thursday through reverse repos at a 0.25 percent rate, up from the $102 billion it borrowed Wednesday at the old 0.05 percent rate. Yet it was ready to do more -- potentially as much as $2 trillion. On Friday, the amount drained climbed to $143 billion.

Before Wednesday’s announcement, in testing the program, the Fed limited itself to $300 billion of daily borrowings through reverse repos. With that cap, policy makers risked not being able to keep market rates elevated if investors offered to lend more than the limit and were forced to take money elsewhere. Officials removed that limit Wednesday, and still didn’t see a big boost in demand for reverse repos.

"There wasn’t a big uptake in size given other money-market rates were higher," said Frank Gutierrez, who helps manage $430 billion in credit and government funds at J.P. Morgan Investment Management Inc.’s Global Liquidity Group in New York and oversees funds that are among the Fed’s reverse-repo counterparties.

Yield Choice

Other options, such as the tri-party repo market, offered yields above the Fed’s new 0.25 percent floor, giving money-market funds more attractive opportunities, said Peter Yi, director of short-term fixed income in Chicago at Northern Trust Corp., another Fed counterparty.

The Fed’s daily reverse repo borrowings will swell in coming weeks, and may reach $1 trillion next year, said Zoltan Pozsar, director of U.S. economics at Credit Suisse Securities USA LLC in New York and a former researcher at the New York Fed and U.S. Treasury.

As the Fed’s rate increase kicks in and money-market funds start advertising higher yields, they’ll probably lure away hundreds of billions of dollars from deposits in banks, which the funds will lend to the Fed through reverse repos, Pozsar said.

Within minutes of the Fed’s announcement Wednesday, banks nationwide raised rates for borrowers. Yet deposit rates are typically slower to adjust higher after rate increases.

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"It’s going to take about a month for the money fund portfolios to turn over," Pozsar said. "When investors start seeing yields in the money funds go up and yields on deposits not go up, that’s when they are going to start to move money."

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