Good afternoon, everyone. When I give a closing keynote I try to
bear in mind that you've been listening for hours to complex and
technical material. I wish I could say that I'm here to offer some
light relief, but, alas, no.
The topic I'm going to address this afternoon is both complex
and technical. It's the recent turmoil in the repo markets and the
Fed's actions to address it.
I'm going to start by laying out the Fed's operating framework
for carrying out monetary policy. This will take me into aspects
of the "plumbing" of the financial system, which may seem like
an esoteric topic to many, but it's one of critical importance, so
please bear with me.
I will then go over the money market turmoil from a month ago
that led the New York Fed to conduct open market operations to
stabilize short-term interest rates. I'll conclude by describing the
path forward as laid out in the Fed announcements this past
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Friday.
Before I go any further, I should give the standard Fed disclaimer
that the views I express today are mine alone and do not
necessarily reflect those of the Federal Open Market Committee
or others in the Federal Reserve System.
Monetary Policy, Interest Rates, and Ample Reserves
As a prelude, it's worthwhile to step back and remember how this
all connects to the Fed's overarching monetary policy goals.
The Federal Reserve has two goals set by Congress: maximum
employment and price stability. The main way we achieve these
goals is by controlling the federal funds rate, the rate at which
banks lend each other money overnight in the form of unsecured
loans. This rate in turn affects overall financial conditions and
thereby the wider economy.
At each of its meetings, the Federal Open Market Committee
(FOMC) decides on the target range for the federal funds rate,
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which currently stands at 1-3/4 to 2 percent.
But how does this work-that is, what keeps the federal funds
rate within the target range? The Fed has an operational
framework in place designed to keep interest rates where the
FOMC wants them. We call this an "ample reserves" regime.
Back in January of this year, the FOMC communicated its
intention to continue to implement policy according to this
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regime.
The key benefit of this approach is that it's a simple, effective
way of controlling the federal funds rate and thereby influencing
other short-term interest rates.
The ample reserves framework has three elements designed to
maintain the federal funds rate within the target range.
The first, not surprisingly, is supplying an amount of reserves
that banks hold at the Federal Reserve that is "ample." By that,
we mean that the supply of reserves is adequate to efficiently and
effectively implement monetary policy. Here, "efficient" means
that the level of reserves is not excessive, relative to what's
needed to be effective. And "effective" means that typical
temporary movements in the demand or supply of reserves don't
cause large changes in the federal funds rate without active
management of reserves. I'll come back to the challenge of
knowing what constitutes "ample" later.
The second element consists of the interest rates that the Fed
itself sets and that influence the federal funds rate. These
"administered" rates, as they are known, include the interest rate
paid to banks on their reserve balances and the overnight reverse
repo rate that the Fed pays to a wider set of money market
participants on a similar, risk-free overnight investment.
These first two elements-an ample quantity of reserves and
administered interest rates-are meant to do the lion's share of
work to keep the federal funds rate within the target range.
But there may be relatively infrequent situations when these two
elements are not enough to keep the federal funds rate within the
target range. Therefore, the third element is the directive from
the FOMC for the New York Fed's Open Market Trading Desk
(the Desk) to conduct open market operations as needed to keep
the federal funds rate within the target range. For example,
through repurchase agreements of Treasury and agency
securities, the Fed can temporarily increase the amount of
reserves in the system.
To support the economy in the aftermath of the financial crisis,
the FOMC increased its long-term securities holdings
dramatically. This led to a similarly large increase in reserves,
which peaked at about $2.8 trillion in 2014. Subsequently,
growth in non-reserve liabilities such as currency and reductions
in the Fed's securities holdings caused reserve levels to decline.
As the level of reserves has come down, we stepped up our
monitoring of the effect of reserve levels on interest rates. The
level of reserves consistent with "ample" is inherently highly
uncertain, so we have been actively looking for signs that
reserves might be growing scarce. Along with in-depth analysis
of conditions in money markets, we conduct surveys of banks
and other outreach to market participants to understand the
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factors that influence the demand for reserves.
To smooth the transition to a level of reserves consistent with the
framework, the FOMC announced a slowing of the pace of the
reduction in securities holdings at its March meeting this year
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and stopped it outright at the July meeting.
Based on a variety of metrics and information, the supply of
reserves appeared ample during the summer and into early
September. The funds rate traded well within the target range
and money markets functioned well.
Recent Developments in Money Markets
With the stage set, I'll turn to market conditions over the past
month and the Fed's actions.
Conditions in money markets became highly volatile about a
month ago. Secured and unsecured rates moved higher and
became more disparate on Monday, September 16, and this
intensified the following day.
We had expected a number of factors-including corporate tax
payments and the settlement of newly issued Treasury securities
-to put some upward pressure on short-term rates. However,
the size of the reaction in repo rates, the spillover to the federal
funds market, and the emergence of strains in market
functioning were outside of recent experience.
In response to the simultaneous increase and widening
dispersion in repo rates and the federal funds rate, on the
morning of Tuesday, September 17, the Fed conducted the first
non-test repo operations in many years, followed by daily
operations. These actions had the desired effect of reducing
strains in markets, narrowing the dispersion of rates, and
fostering conditions in money markets to keep the federal funds
rate within the target range. To ensure that the federal funds rate
remained within the target range going forward, we announced
daily overnight and regular term repo operations, which
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continue to this day.
The Path Forward
Our open market operations have succeeded at keeping the
federal funds rate within the target range and have stabilized
conditions in short-term funding markets.
At the same time, recent experience has provided important
lessons for the successful operation of the ample reserves
framework.
A confluence of events contributed to the volatility in money
markets a month ago. But one telling observation is that when
increases in the Fed's non-reserve liabilities caused the level of
reserves to fall well below those prevailing during summer and
early September, strains in money markets emerged. And when
the prior level of reserves was quickly restored through
temporary open market operations, normal interest rates and
market functioning returned.
In light of these events, we have learned that the ample reserves
framework has worked smoothly with a level of reserves at least
as large as we saw during summer and into early September.
Although temporary open market operations are doing the trick
for the time being, anticipated increases in non-reserve liabilities
would cause reserves to decline in coming months without
further actions.
Based on these considerations, last Friday the FOMC announced
that the Fed will be purchasing U.S. Treasury bills at least into
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the second quarter of next year. Specifically, the Desk
announced an initial monthly pace of purchases of $60 billion.
These permanent purchases will, over time, bring the underlying
level of reserves-by which I mean absent temporary open
market operations-to a level consistent with the ample reserves
framework on a sustained basis.
In concert with these purchases, the FOMC announced that the
Desk will continue temporary overnight and term open market
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operations at least through January of next year. This
combination of permanent Treasury bill purchases and ongoing
temporary open market operations is designed to provide
effective control of the federal funds rate over the next several
months.
I should emphasize that all of these actions are aimed at the
implementation of monetary policy and do not in any way
represent a change in the stance of monetary policy. The goal is
to make sure that the federal funds rate stays within the target
range set by the FOMC.
As we move forward, we will continue to learn about demand for
reserves and other Federal Reserve liabilities and market
functioning, and may adjust the specifics of the plan as
appropriate.
What Does All of This Mean for SOFR?
That's a lot on monetary policy, interest rates, reserves, and
repos.
But before I close, I'd like to emphasize an important point about
a particularly important repo benchmark rate, and that's the
Secured Overnight Financing Rate, or SOFR. SOFR is the
reference rate that the Alternative Reference Rates Committee
(ARRC) has selected as the preferred replacement for LIBOR.
At the same time that we saw turmoil in the repo market, we saw
a temporary spike in SOFR. As market participants make
preparations to transition away from LIBOR, they're
understandably watching SOFR very closely.
There are a few things I'd like to highlight with respect to SOFR.
First, a temporary spike is not surprising, given that SOFR
reflects rates on real-world transactions. Second, the very fact
that we saw a spike in SOFR is an indication of how
representative of its underlying market it is. It's based on actual
transactions, rather than judgment (like LIBOR), which is part of
what makes SOFR so robust. Third and final, is that in the vast
majority of use cases, the relevant metric for SOFR is an average
over time. Focusing on overnight SOFR isn't particularly useful
in this context, as financial contracts will generally refer to an
average of SOFR over many weeks or months.
My message to you is: Don't let last month's temporary spike in
SOFR, or hope for the creation of some other replacement
reference rate, become an excuse for delaying your transition
away from LIBOR. I've said it before and I'll say it again: like
death and taxes, the end of LIBOR is unavoidable, and we must
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do all that it takes to prepare for a LIBOR-less future. And the
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existence of LIBOR is only guaranteed for another 807 days.
Conclusion
I've talked through a lot of important issues this afternoon, and I
greatly appreciate your attention.
The events I've described are an apt reminder of the importance
of well-functioning financial markets and the vital role the
Federal Reserve plays in providing liquidity. They are also a
demonstration of our ability to act swiftly and effectively to
execute our monetary policy implementation goals and keep the
federal funds rate within in the target range.
Thank you.
Board of Governors of the Federal Reserve System, Statement Regarding Monetary
Policy Implementation, October 11, 2019.
3
Board of Governors of the Federal Reserve System, Statement Regarding Monetary
Policy Implementation and Balance Sheet Normalization, January 30, 2019. Further
details were announced in Board of Governors of the Federal Reserve System, Balance
Sheet Normalization Principles and Plans, March 20, 2019.
4
For an example of such a survey of banks, see Board of Governors of the Federal
Reserve System, February 2019 Senior Financial Officer Survey.
5
Board of Governors of the Federal Reserve System, Balance Sheet Normalization
Principles and Plans, March 20, 2019; Board of Governors of the Federal Reserve
System, FOMC Statement, July 31, 2019.
6
Federal Reserve Bank of New York, Statement Regarding Repurchase Operations,
September 20, 2019.
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Board of Governors of the Federal Reserve System, Statement Regarding Monetary
Policy Implementation, October 11, 2019.
8
Board of Governors of the Federal Reserve System, Statement Regarding Monetary
Policy Implementation, October 11, 2019.
9
John C. Williams, LIBOR: The Clock Is Ticking, Remarks at the 2019 U.S. Treasury
Market Conference, New York (September 23, 2019).
10
John C. Williams, 901 Days, Remarks at the Securities Industry and Financial
Markets Association, New York (July 15, 2019).