The future holds various material changes that will impact how banks currently manage liquidity. We have not had an active Fed Funds market since 2008 but we believe it may be about to start up. As rates continue to rise, it might be time to reverse a portion of the Fed’s $2T of liquidity that currently resides on their balance sheet and return another monetary policy lever back to normal.
Tag: Fed Funds
We have laughed about it for years at banking conferences, but rates at one bank, have in fact, gone negative. While earning interest on deposits has been a long held precept in banking, the Alternative Bank Schweiz (ABS), a community bank in Switzerland, is the first bank in history that has moved an entire product line to negative rates. As of this week, retail customers get charged 12.5 basis points for short-term deposits and 75 basis points on deposits above 100k Swiss Francs ($98,202).
The Federal Reserve Bank of New York announced this week that it will plan to alter the calculation methodology for the main policy rate in order to include a larger number of transactions. The iconic benchmark federal funds rate, currently calculated by taking the average of overnight brokered trades between banks, will now include trades done (and reported) directly between counterparties.
While it is debatable when the Fed will raise interest rates, we now know we are getting closer. In all likelihood, October marks the end of the Fed’s Quantitative Easing Program and now the question is just how the Fed will reverse a large portion of the $4.4T of investment that sits on our Nation’s balance sheet. Of greater interest to banks is what mechanisms the Fed will use and what banks need to know to take the best advantage of the unprecedented size of the liquidity reversal.
If you were a financial institution on the frontier during the late 1700’s you had an exchange rate for beaver pelts. Sometimes you didn’t trade any beaver pelts, or some problem customer brought in some deer skins to trade for cash and you had to either make up a beaver pelt rate or do some esoteric conversion in order to have an accurate index rate to base some of your deposit and lending activities on. Well, the beaver pelt problem isn’t all that different than our modern rate structure with LIBOR, Fed Funds and Prime, which is why it is changing.
The short answer: 3Q 2015. However, the analysis is interesting. Working backwards from this analysis, it means that banks will start to feel the real impact (and should be talking to clients proactively) around 2Q of 2014.