As good a reference piece from one who couldn’t be in a better seat to ‘splain it. Lorie Logan herself is a co-author so I thought I should leave this here, in case. First here’s a visual from FRED
And without further delay, from Liberty Street Econ dept,
Jumping TO the notes conclusion,
To Sum Up
To circle back to the beginning of the post, in the recent environment of abundant reserves, the ON RRP facility is working as expected. It is providing a floor under the fed funds rate and moderating the growth in reserve balances as the Fed continues to provide support to the U.S. economy.
And now we know…
Now before Liberty St update hit the inbox, the following (so, completely UNRELATED thoughts) from ZP arrived
Global Money Dispatch
Since our last Dispatch, we received some detailed questions from two London-based clients about how wide we think the EFFR-SOFR spread can get after the first hike, and what flows are likely to police the width of that spread? We’ll answer these questions through a series of three Dispatches this week. First, we’ll discuss what will determine where SOFR sets. Second, we’ll discuss what will determine where EFFR sets. Third, we’ll discuss the “policing” flows.
In both scenarios we laid out last week, we have the rate on the o/n RRP facility at 25 bps, in line with the bottom of the target range. We do not think that the Fed will maintain the current 5 bps premium on the o/n RRP facility relative to the bottom of the target range once it lifts off from zero a few months from now. If we are right and the Fed raises the rate on the o/n RRP facility to 25 bps, where will SOFR trade the next day? We’ll answer this question in three steps.
First, where will bills trade? Certainly below the new o/n RRP rate, that is, below 25 bps. We aren’t going to go back to an environment defined by a glut of bills anytime soon (certainly not this year), and so we do not need to worry about bill yields “trespassing” into the target range and pushing the position of o/n rates up within the target range. We’ve seen such instances of “trespassing” from 2018-2021, a period where bill yields traded above the o/n RRP rate, and so o/n tri-party repo rates (TGCR) priced off bill yields, not the RRP rate. The first two charts show this episode of trespassing: instead of the RRP rate, bill yields served as the lower bound for o/n rates during 2018-2021 – we went from a leaky floor to an “escalator”. Now, the escalator is off and so o/n rates are pricing off the o/n RRP rate like they did from 2015-2018 (see chart three).
Second, if there is $1 trillion of excess cash in the RRP facility, it’s unlikely that o/n tri-party repo rates will trade at a spread to the post-hike o/n RRP rate – we think TGCR will continue to trade flat to RRP, with (practically) no volatility.
Third, if TGCR trades flat to the o/n RRP rate, then SOFR won’t trade more than 2 bps wider. In the near term, SOFR will likely trade flat to TGCR, and any spread won’t average more than the 2 bps we’ve seen since the era of sponsored repo began (chart four). We won’t go back to the pre-2018 era of wide and volatile repo spreads that complicated the lives of RV hedge funds.
Thus, if the o/n RRP rate and not bill yields is the floor to o/n interest rates, with so much excess liquidity and “limitless” balance sheet via sponsored repo, TGCR will likely print at 25 bps with the first rate hike and SOFR flat to TGCR – a 20 bps hike in the RRP rate should widen the current EFFR-SOFR spread from 3 bps to 8 bps. Tomorrow we’ll continue with the determinants of EFFR.
For more (ie info graphics ZP included), HERE is link