Does The FED Raise: Answers Are Found In Facilities

Fed Funds Effective rate in January was 0.09, today 0.12 but highs of 0.13 were seen. The point at 0.09 was the 5 year average in January, today that average is 0.12. What's vital concerning the 5 year average is its not only exactly where the Fed Dot Plots are located but the goal of the Fed is to ever so slowly raise the effective rate by means through two facilities: Fixed Rate Overnight Reverse Repurchase Agreements and Interest on Excess Reserves.

The goal of both facilities is to release Fed bond holdings in Repurchase Agreements but contained within small channels between the two newly created tools. The ON RRP serves as the bid side of the channel and is designed to set a floor for Effective Fed Funds while the IOER are offer rates and serves as a celing. Excess Reserves are currently running in millions last quarter at 2,583,707. The intention of the fed is never to allow higher interest rates to surpass offer rates so interest is controlled purposefully within small ranges and moved higher slowly over time.

The beginning goal was to allow bid and offer rates to hold inside a 0 - .05 channel. When Fed Funds was 0.09 in January, the range points between 0- 0.05 held. Just three months later, range points increased along with Fed Funds Effective rates.

The goal of the Fed before liftoff is to bring range points higher to create a satisfactory floor so an actual announcement of a hike becomes a formality. But as ranges head higher so does Fed Funds in unison. The current channel is only 5 basis points and Fed Funds at 0.12 is only half of the overall target range between 0 - 0.25. The Fed has ability to increase the overall size of the range to 10 basis points but has yet to do so.

The complementary example is the RBNZ since they raised three times but lifted off from far above a 5 year average and they achieved equilibrum, the natural rate after the third rise. Fed funds from a 5 year average is contained between 0.12 - 1.72. The point at 1.72 is the equilibrium point for the US economy. The Fed has a long way to go to achieve its long run goals.

The purpose to establish both facilities was to specifically unload treasury bonds only. Possibly the reason why hesitation to raise is seen from the Fed is due to the expectation both facilities would've experienced a greater success in terms of moving the effective rate further than its present location. Another factor maybe CPI.

If CPI in terms of the price level at 0.2 Vs its M2 counterpart is considered, the current gap is running at 7.5 and must be closed in order for CPI to achieve its long run 2% goals. A drop in CPI as M2 remains stasis or rises risks deflation. The Repo facilities are the answers to the when and if the Fed raises or holds steady.