Fed Liftoff Catapulting Money Market Rates

After the Federal Reserve raised its benchmark interest rate for the first time in almost a decade, the Day One follow-through in money markets shows the policy move looks to be working.

The overnight U.S. dollar London interbank-offered rate, known as Libor, fixed at the highest in more than six years Thursday. The rate, which signals where banks think they can borrow from each other, was posted by Intercontinental Exchange Inc. at 6:45 a.m. in New York at 0.3614 percent, the highest since March 31, 2009. It's up from 0.1315 percent a week earlier and 0.0852 percent at the end of last year.

In the lead-up to the Fed decision, investors voiced skepticism that policy makers would be able to push rates as high as intended, because officials are using a new set of tools to engineer the move. One key question was whether the central bank would expand its reverse repo facility sufficiently to lift the floor for the funds rate. The Fed allayed that concern Wednesday by removing a cap on the program, which siphons excess cash from the system.

“The market is certainly on track” in responding to the Fed's policy, said Aaron Kohli, a fixed-income strategist in New York for BMO Capital Markets, one of 22 primary dealers that trade with the Fed. “It looks like rates are moving fairly well. Broadly, the Fed should be fairly effective in draining excess reserves, and that should put pressure on the front-end rates.”

The federal funds rate opened Thursday at 0.35 percent, compared with the 0.14 percent open on Wednesday, according to ICAP Plc, the world's largest inter-dealer broker. Funds traded between 0.08 percent and 0.55 percent on Wednesday, according to data posted to the New York Fed's website Thursday.

The Federal Open Market Committee voted Wednesday to set the new target range for the federal funds rate at 0.25 percent to 0.5 percent, up from zero to 0.25 percent.

The general collateral Treasury repurchase-agreement rate, a gauge of such transactions between dealers, traded at 0.47 percent at 8 a.m. in New York, up from the close Wednesday of 0.35 percent, according to ICAP. The average rate for all GCF repo on Wednesday was 0.4 percent, according to a Depository Trust and Clearing Corp. index.

In an overnight repo, borrowers take cash from counterparties and post securities as collateral, then unwind the trade the next day. Repo rates have been climbing this week ahead of the start of Fed tightening and amid the normal yearend volatility in money markets, as dealers shore up balance sheets.

The central bank on Wednesday increased the interest it pays on its overnight reverse repos, to 0.25 percent from 0.05 percent, to put a floor at the lower end of the range and removed the cap on the aggregate size of the daily facility. It also raised the interest it pays on excess reserves held at the Fed to 0.5 percent from 0.25 percent to mark the upper end of the range.

The Fed's willingness to boost its reverse-repo facility, previously capped at $300 billion per day, means all the operations will come at the new fixed rate of 0.25 percent. The Fed conducts reverse repos with primary dealers and money-market mutual funds.

The New York Fed drained $105 billion at a fixed rate of 0.25 percent Thursday in the first reverse repo operation since the Fed's announcement Wednesday. There were 49 bidders for the RRPs, as they are known. Wednesday, when the $300 billion cap still existed, the RRP tallied $102 billion at the prevailing rate of 0.05 percent.

As the central bank's monetary policy contraction starts gearing up, traders will watch out for Friday morning, at about 8 a.m. New York time, when the first post-liftoff federal funds effective rate print is published.

The effective rate is based on trades the previous day and is the main rate the Fed is targeting. The central bank's plan is to have it float now between 0.25 percent and 0.50 percent.

–With assistance from Matthew Boesler and James Holloway.

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