Building a Mystery

or- How I stopped worrying about the full allotment fixed rate reverse repo facility and learned to love banging into the sides of the corridor using the death star to catch me.

The Fed is meeting and everyone is talking about "the Funds" rate. The 2 year note was even a topic a conversation on Twitter. Its always nice to see the herd come back to the short end after wild adventures out on the curve. Welcome back weary travelers, we didn't miss you.

The Fed has publicly talked up the idea that the IOER rate will be the primary tool for "exit." Sounds nice, isn't true and shadows over the fact that Fed effective rates are a spread to the Death Star in practice if only kinda theory. So, some numbers:

The IOER rate is 25bp. The D-Star rate is 5bp. The FF corridor is 0 to 25bp. OR, as Matt Boesler would calculate 5 to 25 because the D Star is the "actual" lower band. (However,  market Repo rates regularly slip below into negative trading.) Then, there's another rate voted upon by a different group of cats called the Discount Rate. This rate is 25 over the upper band, or 75bp presently. For the record, Minn. voted to  lower it to 50 and Philly, Clev, and Dallas voted to raise it to 1.

Tomorrow, Yellen and her team may, or may not, adjust ALL of these rates. To avoid universal brain numbing, the media (and most likely the presser) will focus on the least important but most easily digested ort that is Fed Funds. Thus, the possible new corridor is 25 to 50. The D Star is 30 and the potential Fed Effective is 38/37. Or, the corridor is 20 to 45 because RRP would be 5 over the lower band and they want a tidy 25.The Disco Rate would go to 1 and the Fed Bank of Minneapolis will kick dirt. All you have to do is assume all the spread relationships stay the same, "they" assure you they won't do it again, no entity with an account has a bad day, no foreign entity that uses the facility takes more and everybody wins.

But, there's a "better" way. The Fed could, under Potter's direction, allow the effective rate to move towards the right side of the EXISTING band. The concern for "flooring" the corridor - a concern that centers on the fear of being "too easy" - is wrong headed on 2 counts. First, the data (and cloudy indecision about going or not) suggest that fear is misplaced. Second, the real fear is rates spinning away to the upside, otherwise why all the balloon floating about "One and Done"?? IOER and the D-Star rates would not need to be adjusted, or marginally at best. This would also expose the elephant in the room that is IOER.

IOER is a monetary tool that, when utilized, means your financial system ,your CB or both is impaired. That's why you have to pay it. A bold-er follow up to moving the effective rate to the IOER rate would be to then STOP paying IOER. You could (would need to) then fire the D Star with authority. If, as most will now argue, all that money would flood the system (it won't) then the worst thing that would happen is the inflation expectations that everyone's been waiting for, like Godot, might finally emerge.

Everything all cleared up now? Piece a cake, right? Hard to believe no one's ever pulled this off before ain't it?


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