Dissecting the Fed’s foreign repo pool – The Foreign Repo Pool Rate (FRPR)


This is the third post in a sequential four-part series on the Federal Reserve’s foreign repo pool.  The previous Parts, I & II (see summaries at the very end of each post), noticed the increasing  size of the pool, analyzed the user base and how the pool fits into the users’ reserve allocation process, but left questions concerning the cause of the reallocation unexamined.

This post starts the inquiry into the multifaceted ‘Why’ question by exploring the most important factor: the foreign repo pool rate (FRPR) and subsequently how the rate is set (with a simple model to calculate a high(er) frequency proxy) and why Basel III regulations and US extensions thereof seem to lead to a structurally higher FRPR, attracting inflows into the pool.

 


III. The Foreign Repo Pool Rate

 

Transactions in a free-market environment should, according to textbook definitions, lead to wealth and/or utility gains for all parties involved. Applying this principle to FOIs lending to the Fed via its foreign repo pool requires an evaluation of the risks and returns this activity entails. Bluntly stated, rationally behaving FOIs should only lend cash to the Fed if relative risks & returns offered by the pool exceed alternatives elsewhere.

From a risk perspective, the evaluation is simple: there is no safer counterparty than the central bank endowed with the authority to create money by crediting its own account. In addition, since the pool is at the end of the day structured as repos, cash lenders receive high quality collateral from the Fed’s SOMA portfolio, i.e. either Treasuries or Agency MBS. If MBS is involved at all, its role is likely small since pre-GFC, the Fed didn’t own any and usually CBs prefer to limit their liquidity operations to the ‘purest’ safe assets, i.e. Treasuries.

An allocation to the foreign repo pool, in consequence, is at least as safe as owing Treasuries. The only distinction, besides some minor operational features, is the interest rate paid to FOIs.

Continue reading “Dissecting the Fed’s foreign repo pool – The Foreign Repo Pool Rate (FRPR)”

Dissecting the Fed’s foreign repo pool – The Foreign Repo Pool Rate (FRPR)

Dissecting the Fed’s foreign repo pool – funding mechanisms


This is the second post in a sequential four-part series on the Federal Reserve’s foreign repo pool. After establishing a preliminary idea of who is responsible for the rise in the pool in the initial post (see summary at the end), Section II validates the majority of the results and then takes a look at how FOIs incorporate the facility into their reserve allocation process by analyzing the funding mechanisms chosen to finance the increased lending to the Fed.

Subsequent posts in this series:


 

 

II. Funding Mechanisms -or- where did the money come from

 

Whenever a FOI increases its ChioCBs (Cash held in other Central Banks) position, changes in the balance sheets of the CB providing the DF, the global private sector and the FOI occur. There are three broad ways for FOIs to increase their cash holdings with other CBs:

  1. by accumulating new reserves
  2. by shifting deposits, currently with private sector banks, to CBs
  3. by selling (usually money-like) assets and placing the received cash with CBs

All three methods share a common last step: the withdrawing of deposits from the private banking system and placing them with CBs. This deposit outflow leads to a decrease in both the assets and liabilities of US banks and is also referred to as an autonomous factor, affecting the reserve level in the banking system, which is outside the direct influence of the Fed. At this time, banks have no problem funding marginal outflows since, after several rounds of LSAP, they hold excess reserves at the Fed. Continue reading “Dissecting the Fed’s foreign repo pool – funding mechanisms”

Dissecting the Fed’s foreign repo pool – funding mechanisms

Dissecting the Fed’s foreign repo pool – the users


This is the first post in a series of four examining the Federal Reserve’s foreign repo pool. After an introduction, it attempts to figure out who is responsible for the rise in the pool since 2014.

Subsequent posts in this series:


The growth of foreign exchange reserves over the past decades gave rise to a new investor class: a class predominantly focused on safety, excessively concerned about the liquidity terms of their investments and a class trying to avoid private counterparty risk at almost all costs.

In a sense, FX reserves managers epitomize the first half of the old saying about the return of capital vs. the return on capital.

In order to fulfil their mandate, FX reserve managers usually have outsized allocations to G10 fixed income instruments with a heavy tilt towards public sector securities. Occasionally there is some equity exposure, though most of it is, in cases where deployment is certain to be in the distant future, outsourced to SWFs. While G10 government bonds are very liquid, most FX reserve managers also hold some cash (usually bank deposits) or cash substitutes (government bills/MMFs/short-term repos) as a first line of defense, with even less duration & credit risk than longer-term bonds.

This liquidity tranche and in particular a rapidly growing place in the US of almost absolute safety is the topic of this series of posts.


 

In a previous article, the cash holdings of a particular FX reserve manager, SAMA, were analyzed. Continue reading “Dissecting the Fed’s foreign repo pool – the users”

Dissecting the Fed’s foreign repo pool – the users

Saudi Arabia’s Cash Reserves & Equity selling

A significant amount of news was created last month by the release of disaggregated Treasury holdings for the Middle East and especially for Saudi Arabia. The recently returned ‘Don of Capital Flow Analysis’, Brad Setser, had some good posts on what new information is contained in the release  and equally important, pointing out the considerable amount of  grey area that still exists (here and here).

What follows, without too many repetitions from the links above, are some supplementary notes, mostly on equities and the currency breakdown & location of the sizeable cash holdings of the Saudi Arabian Monetary Agency (SAMA).

Equities & Agencies

The release of the ‘Annual Cross-U.S. Border Portfolio Holdings ‘ by the Treasury last week went almost unnoticed even though it contained the second half of disaggregated data from BBG’s FOIA request. Again, as with the initial Treasury Holdings release around mid-month, there wasn’t too much to be learned from the total holdings, if only because the data is almost a year old by now. Continue reading “Saudi Arabia’s Cash Reserves & Equity selling”

Saudi Arabia’s Cash Reserves & Equity selling

China’s ‘hidden’ current account deficit; invoicing decisions and liquidity effects on EMs

SUMMARY

  • China’s current account is responsible for a substantial portion of the reserve decline
  • caused by unfavourable changes in export & import conversion ratios and invoicing decisions
  • current account contribution to reserves even more volatile than the capital account
  • the acceptance of CNY/CNH as an invoicing currency in Asia is at risk as trade partners require US $ payments
  • further pressure on EM vendor financing mechanism

 

As another month has come to a close, it’s almost time again to recycle the competitive devaluation and capital flight stories published over the last six months. Although the declining reserve position last year was reported widely, the mechanism of the various flows and their consequences have often been left unexplored. Continue reading “China’s ‘hidden’ current account deficit; invoicing decisions and liquidity effects on EMs”

China’s ‘hidden’ current account deficit; invoicing decisions and liquidity effects on EMs

Foreign currency credit in China, Pure offshore transactions and attempts to reconcile BIS and PBOC data

While the author believes to have a decent understanding of G7 markets, he is not an EM specialist. Familiarity with the datasets used is thus tenuous at times and results, particularly sections towards the end, should for the moment rather be seen as hypotheses than affirmative statements. Criticism & feedback is welcome.

(Rough) Outline:

  • Compilation of foreign currency assets and liabilities by type and source
  • Pure offshore transactions
  • World ex-China exposure to Chinese non-financial corporations
  • Developments after the August mini-devaluation

Data:   

  • BIS: Local banking statistics (LBS); Consolidated banking statistics (CBS); Debt securities statistics
  • PBOC: Sources & Uses of Credit Funds of Financial Institutions (in FC)
  • MAS: External assets and liabilities
  • HKMA: External claims and liabilities

 

Foreign currency balance sheet of Chinese non-financial companies

Note: The following line of thought deems Chinese (CN) banks in aggregate unable to ‘carry trade’ due to regulatory constraints and more comprehensive oversight compared to non-financial corporations (NFCs). The net position of single banks surely fluctuates intraday to accomdate customer flows; quarter end on-balance & off-balance exposure is remarkably stable though, oscillating between -1% and +1% of total assets.

[Chart 1] is regularly presented in discussions about the size of foreign currency (FC) lending to CN companies.

1
[Chart 1]

While trends are accurately represented by this time series, quite a few adjustments would have to be made, as it includes superfluous categories and omits necessary ones, to attain an accurate picture of total FC lending to CN NFCs. The non-participation of CN in BIS statistic panels (more on this later) doesn’t facilitate the analysis, consequently it appears best to construct the FC balance sheet of NFCs in CN line by line. Continue reading “Foreign currency credit in China, Pure offshore transactions and attempts to reconcile BIS and PBOC data”

Foreign currency credit in China, Pure offshore transactions and attempts to reconcile BIS and PBOC data