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)”

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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