Rates Spark: Setting A Course For Change

The key theme from the Fed's minutes was preparedness, including a key discussion on the permanent repo facility, which in fact looks beyond the taper. But market rates need to be higher beyond the taper too, or this Fed won't be in a position to do much hiking at all.

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So what did the Fed have to say about market rates? Not much, but there's an issue

With respect to the fall in market yields, the Fed notes policy communication, investor positioning and the pandemic as driving factors. There was no particular role noted for the macro economy, or any data impact. Rather the Fed preferred to focus on the technical explanation of a fall in the term premium reflecting the above-mentioned factors. There was not much more discussion beyond that on why rates are where they are or to what extent they signal anything if at all.

What will be a factor ahead is the need for higher market yields so that the Fed has room to ultimately hike rates in the coming years. This is not for the here and now, but it is something that will be on the radar once the taper is complete, which on our interpretation of events would be around the middle of next year. So, to facilitate that, we argue that there needs to be a tantrum. If the Fed has a taper announcement and/or taper and there is no tantrum at all, that in fact is a problem for the Fed. The Fed may not have said it, but they will be aware that this is an issue. 

The new permanent repo facility and what it prepares us for

The  Fed minutes contained some interesting discussion on the Fed's permanent repo facility. This is a new facility, one that effectively allows the market to generate reserves by posting collateral at the Fed. In simplistic terms it makes bonds equal to cash for eligible counterparties, which is significant. It's not relevant for the here-and-now of course, as the market is long reserves and short collateral - hence the  USD 1trn of excess cash going back to the Fed on on a daily basis on the reverse repo facility.

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Disclaimer: This publication has been prepared by the Economic and Financial Analysis Division of ING Bank N.V. (“ING”) solely for information purposes without regard to any ...

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