The Fed's New Target: Part I

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— click here for ProMoney markets have experienced yet another quiet year-end. Just a week after ending its balance-sheet taper — where officials shrink the central bank balance sheet via QT1 — the U.S. central bank has commenced an onslaught of reserve injections, marking the start of a Great Compression in money-market rates. Year-end will soon turn into a distant memory, with repo rates (SOFR) set to print well below the Fed’s new fixed SRP (Standing Repo) rate while emergency Fed volumes top out. Large U.S. Treasury (UST) issuance combined with tighter liquidity was destined to make rate spikes a regular feature of the o/n (overnight) rates complex. Yet, the Fed’s RMOs (reserve management operations) have thwarted any chance of a plumbing “hard landing”2. The subsequent Great Compression should not just contain rates within the U.S. central bank’s limits but enable officials to enforce a fully secured standard, no longer targeting overnight Fed Funds (o/n FF) but one of its numerous repo benchmarks. A target rate evolution is looming.click to enlarge (best viewed on desktop, available in light mode)Just as the Fed’s new permanent open market operations (POMOs) have commenced3, a lengthy balance-sheet winter has concluded. Banks' balance sheets, upon the year-end “air pocket” in money markets4, are now destined to expand rapidly, with expected plumbing relief priced in. The lengthy “tug of war” in (swap) spreads, Conks’ real-time gauge for measuring UST market frictions, has ended with an easing of constraints as the victor. This outcome was decided5 in part via one of t…