Tuesday, July 8, 2014

Update on the Fed's new Term Deposit Facility

Its been a few months since my earlier post discussing the Fed's new Term Deposit Facility. Since then, the scope of this program has grown significantly, with auctions growing from around $25 billion per week, to a massive $125 billion in last week's auction.

These term deposits are simply one-week CD's offered by the Fed. Participating depository institutions have their reserve accounts debited, and then re-credited 7 days later, plus the small, but free amount of interest. While each institution can only tender a maximum of $10 billion, the amount of participating institutions has more than doubled since March of this year-- from 27 to 58. Not surprisingly, this growth in participation follows the Fed's gradual raising of the rates it will pay, from 26 basis points in March, to 30bp just today. Not surprisingly, the 26bp auctions had fewer participants than the 29 bp auction, since many institutions likely figured that getting a one-basis point spread over what they receive on their excess balance accounts (25bp) was not worth the trouble. For now, the Fed has stated that 30 basis points will be the ceiling for this round of term deposit auctions, with the first 30bp auction set to go off today.

The size of this latest auction demonstrates the ease to which the Fed can drain reserves if it chooses to. It simply states the rate that it will pay on term deposits,  and accepts bids. Last week in a matter of hours, the Fed was able to drain $125 billion in reserves from the banking system, with no problems. It will be interesting to see how much higher the Fed may decide to pay on its Term Deposits, and how large these auctions may become as a result. Unfortunately, the Fed states on multiple TDF related pages that the auctions "are a matter of prudent planning and have no implications for the near-term conduct of monetary policy."

It remains to be seen if this statement holds true in the future, since it seems to me that these term deposits are an easier way of raising rates if the Fed needs to, as opposed to trying to sell off their securities portfolio and expose themselves to potential losses. From a political standpoint, it will certainly be easier to expand the TDF than to try and "unwind QE", as many analysts put it.