Reshaped Fed Funds Market
The Federal Reserve Bank of New York posted a piece on its "Liberty Street Economics" blog entitled, "How Have High Reserves and New Policy Tools Reshaped the Fed Funds Market?" The intro states, "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." It continues, "Measuring the size of the fed funds market has been challenging traditionally. Practitioners and researchers have resorted to regulatory filings to estimate the amount of fed funds sold and purchased at quarter-ends. On March 1, the New York Fed began publishing aggregate data on fed funds volume (see announcement), which will make these data easily accessible for future research." The blog adds, "As of the end of 2015, borrowing in the fed funds market reached $56 billion, a big number to be sure, but only about a fourth of its size ten years ago and down from a peak of $280 billion in the first quarter of 2008. The main decline in fed funds volume occurred in late 2008 as the level of reserves in the United States rose to unprecedented levels. As excess reserves increased, the need to borrow fed funds to meet reserve requirements and to clear balances gradually disappeared and many participants exited the market. Over the last two years, the market has stabilized at around $50 billion on quarter-ends. Data published by the New York Fed show a sharp drop in daily volumes from an average of $69 billion in March to $50 billion at the end of the first quarter. This is consistent with incentives to reduce liabilities at quarter-end to meet regulatory requirements such as the Liquidity Coverage Ratio. This quarter-end effect and its impact on fed funds rate volatility was analyzed in a recent Liberty Street Economics post."
