HALISTER1: Fed Steepening May Stumble on Regulatory Barriers, Debt Ceiling

Fed Steepening May Stumble on Regulatory Barriers, Debt Ceiling

(Bloomberg) -- Money market regulatory reform and impending reinstatement of the debt ceiling would likely complicate the Fed’s ability to manage the short-end and slope of the yield curve.
  • Regulation has impeded banks’ and prime money funds’ ability to arbitrage between policy (IOER and RRP) rates and markets, which creates “much noisier policy,” RBC strategist Mike Cloherty says
    • It means Fed has “less firm control over market rates because private rates can drift further from the policy rates”
  • Boston Fed President Rosengren in Oct. 14 speech said Fed’s balance sheet could be adjusted to steepen the yield curve; he subsequently said in interview with MNI that Fed could either swap MBS for T-bills or swap longer-term for shorter- term securities
  • MBS swap is an “odd policy prescription” since the Fed would be replacing a short duration asset with another, Cloherty said; “It’s one thing if they remove or add long duration”
  • Doubtful Fed “will be able to compete in the T-bill space” since collateral needs “will remain high” given money fund reform is in place, Nomura strategist George Goncalves says in Oct. 17 note
    • “The more we explore Fed balance sheet options, the more we come back to our original thesis that it is not going to reduce assets any time soon”
  • As a result of money market reforms, government funds have seen inflows that brought total assets under management (AUM) to $2.109t in week ended Oct. 12, according to ICI data, which increases demand for secured short-term paper
    • At the same time bill supply only went up $200b, Cloherty says
    • Govt money fund inflows supported Treasury’s record day of bill issuance on Oct. 11 when it sold $138b across four tenors; all but one of the auctions stopped through its WI level
  • T-bills may see a squeeze in 1Q 2017 as the Treasury will need to shrink its cash balance, currently ~$375b, before the debt limit is reinstated in March
    • Related story: Money Market Reforms May Create T-Bill Squeeze in 1Q: BofAML
  • In paper presented at Jackson Hole Symposium Aug. 26, Stanford University’s Darrell Duffie and Arvind Krishnamurthy said current regulatory regime, especially money market reforms and supplementary leverage ratio, is impairing the Fed’s transmission mechanisms
    • Suggested increase in Treasury bill supply, improvements in repo market infrastructure would help market operate with “less intensive use” of dealer balance sheets
  • Related story: Limited Support on FOMC for Rosengren Curve View: Strategists
Alert: HALISTER1
Source: BFW (Bloomberg First Word)

People
Arvind Krishnamurthy (Paragon Outcomes Management LLC)
Eric Rosengren (Federal Reserve Bank of Boston)
George Goncalves (Nomura Holdings Inc)
Michael Cloherty (RBC Capital Markets LLC)

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