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The price impact of a trade derives largely from its information content. The “workup” mechanism, a trading protocol used in the U.S. Treasury securities market, is designed to mitigate the instantaneous price impact of a trade by allowing market participants to trade additional quantities of a security after a buyer and seller first agree on its price. Nevertheless, workup trades are not necessarily free of information. In this post, we assess the role of workups in price discovery, following our recent paper in the Review of Asset Pricing Studies (an earlier version of which was released as a New York Fed staff report).
As a consequence of the Federal Reserve’s large-scale asset purchases from 2008-14, banks’ reserve balances at the Fed have increased dramatically, rising from $10 billion in March 2008 to more than $2 trillion currently. In that new environment of abundant reserves, the FOMC put in place a framework for controlling the fed funds rate, using the interest rate that it offered to banks and a different, lower interest rate that it offered to non-banks (and banks). Now that the Fed has begun to gradually reduce its asset holdings, aggregate reserves are shrinking as well, and an important question becomes: How does a change in the level of aggregate reserves affect trading in the fed funds market? In our recent paper, we show that the answer depends not just on the aggregate size of reserve balances, as is sometimes assumed, but also on how reserves are distributed among banks. In particular, we show that a measure of the typical trade in the market known as the effective fed funds rate (EFFR) could rise above the rate paid on banks’ reserve balances if reserves remain heavily concentrated at just a few banks.
Note: This analysis provides insight into how the fed funds market might react to changes in the aggregate level of bank reserves. However, as it does not account for all relevant factors, it should not be construed as an analysis of any specific time period. In particular, our analysis does not incorporate the technical adjustment introduced by the FOMC on June 13 that lowered the interest paid on banks' reserves relative to the top of the target range.
In recent months, there have been some high-profile assessments of how far the Federal Reserve has come in terms of communicating about monetary policy since its “secrets of the temple” days. While observers say the transition to greater transparency “still seems to be a work in progress,” they note the range of steps the Fed has taken over the years to shed light on its strategy, including issuing statements to announce and explain policy changes following Federal Open Market Committee (FOMC) meetings, post-meeting press conferences and minutes, FOMC-member speeches and testimony, and “forward guidance” in all its variants.
Over the last decade, the federal funds market has evolved to accommodate new policy tools such as interest on reserves and the overnight reverse repo facility. Trading motives have also responded to the expansion in aggregate reserves as the result of large-scale asset purchases. These changes have affected market participants differently since, for instance, not all institutions are required to keep reserves at the Fed and some are not eligible to earn interest on reserves. Differential effects have changed the profile of participants willing to borrow and lend in this market, and this shift provides an opportunity to study how unconventional policy actions shape participant incentives. In today’s post, we take a detailed look at regulatory filings to identify the main players in today’s fed funds market and understand how their roles have evolved.
Few people know the Treasury market from as many angles as Ken Garbade, a senior vice president in the Money and Payments Studies area of the New York Fed’s Research Group. Ken taught financial markets at NYU’s graduate school of business for many years before heading to Wall Street to assume a position in the research department of the primary dealer division of Bankers Trust Company. At Bankers, Ken conducted relative-value research on the Treasury market, assessing how return varies relative to risk for particular Treasury securities. For a time, he also traded single-payment Treasury obligations known as STRIPS—although not especially successfully, he notes.
The Federal Open Market Committee implements monetary policy by raising or lowering its target for the federal funds rate, the interest rate banks charge each other for overnight loans. Because the Federal Reserve has no direct control over most interest rates, it relies on arbitrage in money markets for the change in the fed funds rate to be transmitted to other short-term rates, thus causing all short-term rates to move in tandem. This transmission to other rates is an important first step for the Fed’s actions to influence the real economy. In this post, we describe the major developments that have affected monetary policy transmission since the recent financial crisis. We conclude that while arbitrage may have been impeded at the beginning of the crisis, it currently remains effective in transmitting changes in monetary policy via the money markets.
Moreno Bertoldi, Paolo Pesenti, Hélène Rey, and Valérie Rouxel-Laxton
On April 18, 2016, the New York Fed hosted a conference on current and future policy directions for the linked economies of Europe and the United States. "The Transatlantic Economy: Convergence or Divergence?"—organized jointly with the Centre for Economic Policy Research and the European Commission—brought together U.S. and Europe-based policymakers, regulators, and academics to discuss a series of important issues: Are the economies of the euro area and the United States on a convergent or divergent path? Are financial regulatory reforms making the banking and financial structures more similar? Will this imply a convergence in macroprudential policies? Which instruments do the United States and the euro area have at their disposal to raise investment, spur productivity, and avoid secular stagnation? In this post, we summarize the principal themes and findings of the conference discussion.
Bonni Brodsky, Marco Del Negro, Joseph Fiorica, Eric LeSueur, Ari Morse, and Anthony Rodrigues
In our previous post, we showed that the gap between the market-implied path for the federal funds rate and the survey-implied mean expectations for the federal funds rate from the Survey of Primary Dealers (SPD) and the Survey of Market Participants (SMP) narrowed from the December survey to the January survey. In particular, we provided explanations for this narrowing as well as for the subsequent widening from January to March. This post continues the discussion by presenting a novel approach called “tilting” that yields insights by measuring how much the survey probability distributions have to be altered to match the market-implied path of the federal funds rate. We interpret any discrepancy between the original and tilted distributions as arising from either risk premia or dispersion in beliefs.
Correction: In the original version of this post, the chart “Average Daily Fedwire Payments Are Higher at Quarter-End” contained incorrect data. The chart has now been updated. We regret the error.
The federal funds market is an important source of short-term funding for U.S. banks. In this market, banks borrow reserves on an unsecured basis from other banks and from government-sponsored enterprises, typically overnight. Before the financial crisis, the Federal Reserve implemented monetary policy by targeting the overnight fed funds rate and then adjusting the supply of bank reserves every day to keep the rate close to the target. Before the crisis, reserves were generally in scarce supply, which periodically caused temporary spikes in the fed funds rate during times of high demand, typically at the end of each quarter. In this post, we show that the Fed actively responded to quarter-end volatility by injecting reserves into the banking system around these dates.
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.
The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
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