hello c2, am in beijing, where an enormous meal for 3 at good airport restaurant (table cloth and all) ran for usd 25
i find it interesting that there is so much buzz and noise about volcker, especially in his old has-been record as inflation fighter
the market has not reflected on the truth that we now have a very different proble, and one that can only be made much worse if put in the hands of an 'inflation fighter'
shrivelling the banks and pulverizing their lending capacity now would bring on ... never mind, too ugly to contemplate
just in in-tray
Please see today's Checking the Boxes.
Recent news headlines seem to suggest that the Fed is getting ready to explicitly change its target rate to the Deposit Rate-the rate paid on reserves deposited at the Fed. As our more faithful readers will recall, we think the Fed is already implicitly targeting the Deposit Rate. So what would officially switching to the Deposit Rate mean?
1. Confirmation that the Fed is Adopting a Floor System: Assuming that the US decides to keep its new Deposit Rate and its existing Discount Rates (the 'penalty rate' for banks seeking emergency funds from the Fed), there are two key options:
a) a 'Channel System' in which the Deposit Rate is the floor, the Discount Rate is the ceiling, and the target rate is somewhere in between. The ECB officially uses a Channel System, though during this crisis it too seems to have drifted from its status quo (see Bernanke & Trichet's Monetary Policy Experiments); b) A Floor System in which the target rate is equal to the Deposit Rate, which allows the Fed to adjust the level of reserves without impacting the Fed Funds rate.
Very clearly, recent events tend to show that the Fed is moving towards a 'Floor System'. As Bernanke himself said in October: "In general, banks will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve." And as Richmond Fed President Lacker said this month: "Since October 2008, we have had the authority to pay explicit interest on the reserve balances banks hold. This gives us the ability to vary independently the amount of our monetary liabilities and a critical overnight interest rate. So when the time comes to withdraw monetary stimulus, the FOMC will be able to raise the interest rate on reserves or drain reserve balances, or both." Explicitly naming the Deposit Rate as the target would simply confirm this move toward a floor system.
2. A non-debated transfer of power towards Washington: The FOMC is made up of the seven members of the Board of Governors, the NY Fed President, and four other Fed Presidents on a rotating basis. This somewhat decentralized structure reflects the United States' historical suspicion of centralized, federal power and the reluctance in many parts of the country to accept a central bank. And in the sharing of power, the FOMC has historically determined the Fed Funds rate while the Board of Governors has had sole control over the reserve requirements and the Discount Rate. But since Congress has already granted the authority to set interest rates on reserve deposits solely to the Board of Governors, and since in 'floor system' the Deposit Rate becomes the target rate, either explicitly or effectively, then we could be witnessing a rather large shift of power away from the Fed Presidents and the NY Fed.
The Richmond Fed President has stirred up all this talk by telling reporters on January 8, that "one option you might want to consider is that our policy rate is the interest rate on excess reserves and we let the Fed Funds rate trade with some spread to that." This very well may occur, perhaps even this week, but our bet is that the Fed will not want to explicitly change the target to the Deposit Rate until it can show that it can maintain a Fed Funds rate much closer to the Deposit Rate (which it has not done in a while, as shown on p. 2). This is for the same reason we think The Fed Won't Raise Its Target Rate Until It Can Hit It. To consistently miss an explicit target is embarrassing for the Fed and unsettling for the markets. If anything, we think it is more likely that the Fed will announce some measure which aims to close the spread between the Fed Funds rate and the Deposit Rate-perhaps in preparation for a later explicit change of the target rate.
GaveKal Dragonomics
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