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There’s an ongoing debate about whether policymakers should respond to financial conditions when setting monetary policy. An argument is often made that financial stability concerns are more appropriately dealt with by using regulatory and macroprudential tools. This post offers a theoretical justification for policymakers to monitor and possibly respond to financial conditions not because this would lessen concerns about financial stability but because this information helps reveal the state of the economy and the appropriate stance of monetary policy.
Marco Cipriani, Julia Gouny, Matthew Kessler, and Adam Spiegel
The Federal Reserve Bank of New York will begin publishing the overnight bank funding rate (OBFR) sometime in the first few months of 2016. The OBFR will be a broad measure of U.S. dollar funding costs for U.S.-based banks as it will be calculated using both fed funds and Eurodollar transactions, as reported in a new data collection—the FR 2420 Report of Selected Money Market Rates. In a recent post, “The Eurodollar Market in the United States,” we described the Eurodollar activity of U.S.-based banks and compared recent fed funds and Eurodollar rates. Here, we look at the historical relationship between overnight fed funds and Eurodollars and compare the new OBFR rate to the fed funds rate.
Jacob Adenbaum, Antoine Martin, and Susan McLaughlin
The tri-party repo market is a large and important market where securities dealers find a substantial amount of short-term funding. Despite its importance, this market was very opaque before the crisis. Since March 2010, in accordance with recommendation 13 of the Task Force on Tri-Party Repo Infrastructure Reform report, the Federal Reserve Bank of New York has made monthly data on the tri-party repo market available to the public. Today, with our new interactive tool, there is a whole new way to view the market and its evolution. You can make your own charts, looking at volumes for specific asset classes, at haircuts, or at concentration, over your preferred time horizon.
The aftermath of the financial crisis and changes in technology and regulation have spurred a spirited discussion of dealers’ evolving role in financial markets. One such role is to buy securities at auction and sell them off to investors over time. We assess this function using data on primary dealers’ positions in benchmark Treasury securities, released by the New York Fed since April 2013 and described in this earlier Liberty Street Economics post.
Market efficiency is often pointed to as a main benefit of automated and high-frequency trading (HFT) in U.S. Treasury markets. Fresh information arriving in the market place is reflected in prices almost instantaneously, ensuring that market makers can maintain tight spreads and that consistent pricing of closely related assets generally prevails. While the positive developments in market functioning due to HFT have been widely acknowledged, we argue that the (price) efficiency gain comes at the cost of making the real-time assessment of market liquidity across multiple venues more difficult. This situation, which we term the liquidity mirage, arises because market participants respond not only to news about fundamentals but also market activity itself. This can lead to order placement and execution in one market affecting liquidity provision across related markets almost instantly. The modern market structure therefore implicitly involves a trade-off between increased price efficiency and heightened uncertainty about the overall available liquidity in the market.
Tobias Adrian, Michael Fleming, Or Shachar, and Erik Vogt
Fifth in a six-part series
Market participants have recently voiced concerns that bond markets seem to become illiquid precisely when they want to sell bonds. Some possible reasons for a decline in corporate bond market liquidity in times of stress include the increasing share of corporate bond ownership by mutual funds and the reduced share of corporate bond ownership by dealers. In this post, we examine the potential effects of outflows from bond mutual funds and the role of dealers’ positioning in corporate bonds.
Tobias Adrian, Michael Fleming, Or Shachar, Daniel Stackman, Erik Vogt
Fourth in a six-part series
Since the financial crisis, major U.S. banking institutions have increased their capital ratios in response to tighter capital requirements. Some market analysts have asserted that the higher capital and liquidity requirements are driving up the costs of market making and reducing market liquidity. If regulations were, in fact, increasing the cost of market making, one would expect to see a rise in the expected returns to that activity. In this post, we estimate market-making returns in equity and corporate bond markets to assess the impact of regulations.
Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt
Third in a six-part series
Market participants have argued that market liquidity has deteriorated since the financial crisis. However, inspection of common metrics such as bid-ask spreads, market depth, and price impact do not show pronounced reductions in liquidity compared with precrisis levels. In this post, we argue that recent changes in liquidity conditions may best be described in terms of heightened liquidity risk, as opposed to general declines in liquidity levels. We propose a measure that shows liquidity risk has risen in equity and Treasury markets and discuss some factors behind the increase.
Tobias Adrian, Michael Fleming, Or Shachar, Daniel Stackman, and Erik Vogt
Second in a six-part series
Recent commentary suggests concern among market participants about corporate bond market liquidity. However, we showed in our previous post that liquidity in the corporate bond market remains ample. One interpretation is that liquidity risk might have increased, even as the average level of liquidity remains sanguine. In this post, we propose a measure of liquidity risk in the corporate bond market and analyze its evolution over time.
Tobias Adrian, Michael Fleming, Or Shachar, and Erik Vogt
First in a six-part series
Commentators have argued that market liquidity has deteriorated in recent years as regulatory changes have reduced banks’ ability and willingness to make markets. In the corporate debt market, dealer positions, which are considered essential to good liquidity, have indeed declined, even as issuance and outstanding debt have increased. But is there evidence of reduced market liquidity? In previous posts, we discussed these issues in the context of the U.S. Treasury securities market. In this post, we focus on the U.S. corporate bond market, reviewing both price- and quantity-based liquidity measures, including trading volume, trade size, bid-ask spreads, and price impact.
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