On Wednesday the Federal Reserve announced it would raise interest rates for the first time since June 2006.
And so on Thursday markets woke up with rates in a new 0.25%-0.50% corridor after spending exactly seven years pinned in a record-low range of 0%-0.25%.
As we’ve written before, by “raising interest rates” the Fed means it is actually moving two rates higher — a lower-band (0.25%) which is its floor for reverse repo operations, and an upper-band (0.50%) which is pays on excess reserves parked at the Fed.
This, in theory, yields a new Effective Fed Funds rate — which had been right around 0.13% over the last seven years — of roughly 0.38%, give or take.
As for how this works, think of the bottom range as the push and the top range as the pull that gets the Fed’s Effective Funds rate, which is used by banks to lend to one another, into the middle of the band.
The real test, then, of whether the Fed would be able to raise rates was set to come on Thursday afternoon when the New York Fed carried out its first round of overnight reverse repo operations.
But according to Bloomberg, citing data from the Fed, Thursday’s reverse repo operation drew bids from 49 of 108 available counterparties for a total of $105.185 billion.
In plain English, market players parked about $105.2 billion in cash at the Fed overnight in exchange for the same amount in Treasury bonds in deals that will be unwound tomorrow. But the really notable part here is that on Wednesday, this same operation drew 46 bidders and around $102 billion.
And so the market reacted, it would seem, almost as if the Fed hadn’t really done anything.
Ahead of this first post-hike reverse repo, on Wednesday the Fed said it was removing a temporary cap on how large its reverse repo facility could be (previously this had been capped at $300 billion) in anticipation that counterparties could flood the system now that rates had been inched up.
But at least as of day one it appears the “plumbing” of the Fed’s system is working. For now.
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