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Where do interest rates go in the US?


Highlights


Since September 2019, the Fed has executed a program to purchase treasury bills, in the order of USD 60 billion per month, through repos, with the purpose of providing liquidity to the short-term financing markets, which are attended by banks and large institutional investors.


The main curiosity of opinion makers in financial markets is what role these purchases play in the medium term. For now, they are expected to remain until the second half of 2020, but the duration of this program is conditioned to the answer to a very difficult question: what is the level of reserves that US banks should maintain to face the peaks in the demand of liquidity, typical of the closing of the month or in the corporate tax payment season?

One of the great challenges of the US Federal Reserve (FED) is to be able to convey in the most innocuous way possible the intention behind its intervention in the financial markets.

Since September 2019, the Fed has executed a program to purchase treasury bills, in the order of USD 60 billion per month, through repos, with the purpose of providing liquidity to the short-term financing markets, which are attended by banks and large institutional investors.


Fed officials insist that these operations should not be confused with a revival of Quantitative Easing (QE), where long-term treasuries are purchased to try to reduce the yields of long-term securities and stimulate investments in the real economy.


Some financial market analysts consider this distinction irrelevant. Whether or not through a QE, liquidity injection has pushed up the prices of stocks and bonds in the US. The upward trend in the stock market could continue if liquidity injection operations are to be maintained indefinitely.


Then, it is no wonder that the main question among opinion makers in the financial markets is about the role these purchases play in the medium term.


For now, they are expected to remain until the second half of 2020, but the duration of this program is conditioned to the answer to a very difficult question: what is the level of reserves that US banks should maintain to face the peaks in the demand of liquidity, typical of the closing of the month or in the corporate tax payment season?


Bank liquidity requirements are set by very short-term transactional dynamics, and these dynamics changed significantly after the Great Financial Crisis of 2009. The central banks of developed countries, and the Fed is no exception, have a low tolerance to fluctuations of the market, which reflects important doubts on how to implement monetary policies in a post-crisis world.


In addition to the mechanism for the purchase of treasuries via repos, the FED has an additional tool to affect short-term liquidity and is to conveniently move the interest rate paid to banks for the excess reserves that they place in this institution or IOER (Interest On Excess Reserves). The FOMC, the FED open market operations committee, raised that rate by five basis points, from 1.55% to 1.60%, on Wednesday, January 29, 2020.


With the rise of the IOER rate, the FED hopes to create the conditions for which the rediscount rate will shift over time from the range of 1.5% -1.75% to higher levels. Let us not forget that the worst thing that can happen to a central bank is that it has to face a strong recession, in a context of low interest rates, which reduces its room for maneuver.

Each January the FED publishes revised versions of its long-term strategies and goals. Also four members of the FOMC are replaced.


This year the Fed decided to defer for a few weeks the publication of these strategic pieces of information, and appointed among the new members of the committee two individuals who strongly favor the rise in the federal funds rate, economists Loretta Mester from Cleveland FED and Patrick Harker from Philadelphia FED; a moderate, Robert Kaplan from Dallas FED, and Neel Kashkari from Minneapolis FED, who is a strong advocate of a low rate level. Do these changes give any clue about where interest rates will go in the US in the next few years?

© 2015 Arca Análisis Económico

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