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September 26, 2013

Is FARP a taper alternative? | Fast start for the new Fed facility

The apparently fast start (Monday) of the Fed's FARP – coming just after the unexpected announcement not to taper – has caused some to speculate this is an alternative to the taper.  But is it?

The apparently fast start (Monday) of the Fed's FARP – coming just after the unexpected announcement not to taper – has caused some to speculate this is an alternative to the taper.  But is it?

FARP for short, FRFARRP (Federal Reserve Full-Allotment Reverse Repo Facility) for long – there was only a brief hint in the quarterly FOMC meeting minutes of this and we are already in "test" ($11bn of repos on the first day – Monday) with a view to being "fully live" in January.  Some initial blogosphere reactions are here:

FT Alphaville – The Greatest Trick the Fed Ever Played (registration but not subscription required)

Scott Skyrm – Fed Officially Announces The Fixed-Rate Full-Allotment RRP

How does this work?   Participants propose to put up overnight cash to the Fed in return for bonds – thus withdrawing cash liquidity from the market and injecting collateral.  Counting 139 participants (including fund level entities in money managers and a limit of $500m cash per entity) the Fed can withdraw up to a maximum of $70bn in cash liquidity on any given day.  That's about 80% of the current monthly QE purchase rate.  Nothing to say they couldn't add participants or raise the limit.

What is this for: Collateral shortage?  Liquidity adjustment?  QE unwind substitute?  Repo rate control? This is subject to conjecture.  My view so far is below.

Collateral Shortage? Fact: FARP allows the Fed to put QE bonds purchased back into the market as available good collateral.   Worth noting also that there are a considerable number of non-bank participants in FARP.  Repo-ing collateral to non-banks only makes it available for that buy side firm as it is unlikely they can re-hypothecate like a bank.

Conjecture: Not yet.  I doubt this is the motivation at least not today.  If it were they would have focused on bank participants.

Why not?  The Dodd-Frank eventual collateral needs are significant but immediate needs are likely small as cleared risk builds slowly as portfolios turn over (taking several years).  Some participants also have plentiful un-leveraged collateral to cover initial IM needs at their custodians.

QE unwind substitute?  Liquidity management?  Repo rate control? Fact: in common with the mooted QE taper this has the effect of withdrawing liquidity / monetary tightening without selling the bonds.   Given multi-trillion injection from QE in aggregate it cannot be considered (without considerable expansion of the participant limits or number of participants) to be an alternative QE unwind in aggregate but does give the Fed the ability to fine tune liquidity on a given day / in a given month.

Conjecture: Not a QE unwind substitute but a fine tuning tool on liquidity and repo rates.  Perhaps the Fed wants to put a positive floor on GC repo rates (to alleviate fairly frequent recent negative repo rates)  and also to be able to smooth out short term liquidity shortages as the QE policy "super-tanker" changes course over time.   This can now happen without making short term changes to QE itself which may be disruptive given recent market (over-)reactions to QE signals. Let's see you this develops over time. Jon


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