At first, I called this post "More on Quarles and the introduction of a standing repo facility". But that's not a sexy title is it? That's because repo isn't a sexy topic. I think it's important though. If we have a liquidity crisis though, everyone will be talking about it - because that's where the financial meltdown would occur.
Markets appear to perceive any increase in bank reserves as an increase in leverage, and hence an increase in liquidity. I think they are again confusing potential leverage with actual bank lending. But this confusion has led to market rallies, which is what is really causing higher liquidity. And so fintwit confusingly now calls everything "liquidity", causing even more focus on central bank actions.
Standing repo should neatly allow total reserves to ebb and flow as needed, but typically for meeting bank liquidity regulations rather than increased lending. The Fed can get back to managing lending volume through interest rates (just not at the discount window). A lot of the ebb and flow will be seasonal, and will mean mega banks don't need to hold extra reserves for seasonal shortages - which alone may allow the Fed to lower total long-term reserves. It will also be particularly good for banks HQ'd outside of the US.
But how will markets perceive this automatic stabilizer? I suspect they will be spooked when they see total bank reserves fall. That is actually what I'd want if I were Powell, since I'd want to dampen the current speculative boom, particularly if he thinks the market is now driven more by speculation on Fed actions than by speculation on future economic outcomes.
So my questions are: when would the Fed implement the standing repo facility, and when would they start lowering reserves?
A good explanation, thank you.
Markets appear to perceive any increase in bank reserves as an increase in leverage, and hence an increase in liquidity. I think they are again confusing potential leverage with actual bank lending. But this confusion has led to market rallies, which is what is really causing higher liquidity. And so fintwit confusingly now calls everything "liquidity", causing even more focus on central bank actions.
Standing repo should neatly allow total reserves to ebb and flow as needed, but typically for meeting bank liquidity regulations rather than increased lending. The Fed can get back to managing lending volume through interest rates (just not at the discount window). A lot of the ebb and flow will be seasonal, and will mean mega banks don't need to hold extra reserves for seasonal shortages - which alone may allow the Fed to lower total long-term reserves. It will also be particularly good for banks HQ'd outside of the US.
But how will markets perceive this automatic stabilizer? I suspect they will be spooked when they see total bank reserves fall. That is actually what I'd want if I were Powell, since I'd want to dampen the current speculative boom, particularly if he thinks the market is now driven more by speculation on Fed actions than by speculation on future economic outcomes.
So my questions are: when would the Fed implement the standing repo facility, and when would they start lowering reserves?