What Is The Purpose Of The Fed Tightening Monetary Policy?

As the Federal Reserve is about to open its first interest rate increase since 2006, the bank's operational framework and its huge balance sheet may challenge the market.

It is very important to ensure the smooth flow of the financial pmission system in the large reverse repurchase program.

For effective monetary policy pmission mechanism, all interest rates should be synchronized with the federal funds rate, which requires a good conduction system.

Through the QE project, the Federal Reserve's balance sheet has increased to more than 4 billion US dollars.

This means that the market share of these bonds has been pferred to the Federal Reserve.

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This is very important because the market interest rate in the market of repo and other collateral is very certain.

Financial agents who make daily profits or losses may require additional cash or collateral, which constitutes the core of financial blood.

Such collaterals are usually collected into banks, which include not only the repo market, but also the securities brokers, the principal brokerage agreements of hedge funds, and the collateral holding of derivatives.

Among them, the largest source of supply of collateral is hedge funds, and other sources include insurance companies, pension funds, central banks and sovereign wealth funds.

Repo rate is an important market signal and should be synchronized with the federal reserve fund rate. Therefore, a good financial pmission system is needed.

However, the collateral market has shrunk from the $10 trillion in 2007 to only $6 trillion today, and the future is likely to shrink further.

With the Federal Reserve approaching the rate hike, the financial pipeline may be in danger of being unsmooth.

Manmohan Singh believes that the Fed has two ways to tighten monetary policy:

The first is to use and expand the so-called reverse repurchase plan.

This way can absorb large amounts of money from non banking channels such as money market funds, but it will not allow collateral to flow back to the collateral market from its balance sheet, because although the collateral is pferred to non banking institutions, asset ownership still belongs to the Federal Reserve.

The second way is to sell the United States.

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This way can also withdraw cash, but at the same time, it will also inject collateral into the market.

This is partly coincided with the speculation of Mark Cabana, a bank of America Merrill Lynch analyst.

Mark Cabana predicts that when the Federal Reserve raises interest rates, it will raise the excess reserve interest rate to 0.5% and raise the overnight reverse repo rate to 0.25%.

In fact, the minutes of the FOMC meeting announced in April 8th showed that Fed officials were considering expanding the overnight reverse repurchase scale to control short-term interest rates after raising interest rates.

In addition, they also consider selling short-term bonds to help reverse the repo rate.

Overnight reverse repurchase project is one of the Federal Reserve's interest rate instruments.

The Federal Reserve used this tool in December 2008 to guide short-term interest rates to near zero levels.

In general, the Federal Reserve will control interest rates by increasing or reducing the number of tools in the interbank system.

At present,

The scale is controlled at $300 billion per day, but the Federal Reserve may raise the ceiling to ensure that enough cash is refunded through reverse repurchase operations to maintain the lower interest rate.

Through reverse repurchase operations, non bank institutions take out the US dollar cash deposited in the bank and exchange it with the bonds held by the Federal Reserve. Thus, the Fed becomes a new counterparty to the non banking institutions, and the banks get the "asset debt table space" because of the cash pfer to the Federal Reserve.

Manmohan Singh said that the key point is that due to the practical restriction on the reutilization of collateral in the process of counter repurchase, the collateral in the Federal Reserve will not be released.

Therefore, the collateral involved in the reverse repurchase operation will not be submitted to the central clearing system for settlement.

The consequences of a huge reverse repurchase project will be that cash is scarce due to being taken away, and then the repurchase rate will be raised. At the same time, collateral will become cheap because it appears to be abundant enough.

Therefore, by controlling the scale of the reverse repurchase, the repo rate can be synchronized with the federal funds rate.

The result, however, is that repo rate is no longer a market adjusted interest rate.

In Manmohan Singh, a better option is to keep the reverse repurchase scale at the present level and sell US Treasury bonds.

These bonds can be divided and cut into separate ones as repurchase and related collateral utilization.

The Federal Reserve can control the amount of treasury bonds sold, and the collateral under the Fed's control can be reused, so the repo rate may not be the same as the federal funds rate.

However, the sale of US Treasury bonds can be fine-tuning to reduce the difference between the two interest rates.