The latest move by the Federal Reserve.
On January 24th local time, the Federal Reserve announced that it will raise the interest rate for bank term financing programs (BTFP) starting from today. The raised BTFP interest rate will not be lower than the effective reserve balance interest rate on the day of loan disbursement. After this adjustment, the BTFP interest rate will be raised by at least 50 basis points. BTFP was launched by the Federal Reserve in 2023 during the explosion of Silicon Valley banks. It allows banks to borrow funds by using US treasury bond bonds and institutional bonds as collateral.
Currently, what the global market is most concerned about is undoubtedly when the Federal Reserve will start its interest rate cutting cycle? Recently, several Federal Reserve officials, on the eve of the silence period, countered market expectations for the Fed's interest rate cut of up to 150 basis points this year, intending to cool the market. Among them, Federal Reserve Governor Waller stated that there is currently no reason to take swift action or cut interest rates quickly. According to the CME Federal Reserve observation tool, the market currently expects the probability of the Federal Reserve cutting interest rates in March to have decreased from 80% a month ago to about 40%.
In addition, the latest GDP data released by the United States also provides a basis for when the Federal Reserve will cut interest rates. On the evening of January 25th Beijing time, data released by the US Department of Commerce showed that the actual GDP of the United States in the fourth quarter increased by 3.3% on an annualized quarter on quarter basis compared to the initial value, slowing down from 4.9% in the previous quarter but far exceeding market expectations of 2%. The US economy grew by 2.5% in 2023 and 1.9% in 2022. Analysts believe that a better than expected GDP may further delay the Federal Reserve's interest rate cuts.
The Federal Reserve suddenly announced
On January 24th local time, the Federal Reserve announced that it will raise the interest rate for bank term financing programs (BTFP) starting from today. The raised BTFP interest rate will not be lower than the effective reserve balance interest rate on the day of loan disbursement.
It should be noted that the regular bank financing plan of the Federal Reserve was launched urgently during the regional banking crisis caused by the Silicon Valley bank explosion in 2023. It allows banks and credit cooperatives to mortgage the US treasury bond bonds and institutional bonds at face value and borrow funds with a term of no more than one year.
Before the Federal Reserve announced a rate hike, the BTFP rate was the one-year overnight index swap rate (OIS)+10 basis points. According to Wednesday's quotation, the BTFP interest rate for that day is approximately 4.88%. By contrast, the current interest rate for depositing cash into the Federal Reserve account is 5.40% - which typically moves in sync with the Federal Reserve's benchmark federal funds rate target.
This means that financial institutions can enjoy risk-free arbitrage of over 50 basis points by borrowing funds through the BTFP program and placing them in reserve balances.
After the Federal Reserve announces the adjustment, the BTFP interest rate will be raised by at least more than 50 basis points. This means that the arbitrage space has completely disappeared.
The Federal Reserve stated in its statement that adjusting the interest rates of bank term financing programs is to ensure continued support for the program's goals in the current interest rate environment. The Federal Reserve added that the other terms of the plan have not changed.
It is worth mentioning that the Federal Reserve has also announced that this temporary tool will end as originally planned on March 11th and cease issuing new loans. Earlier in January 2024, senior Federal Reserve officials revealed that the plan would not be extended beyond the March 11 deadline.
The Federal Reserve stated in a press release that during the tense period of spring 2023, bank term financing programs helped ensure the stability of the banking system and provided support for the economy. After March 11, 2024, banks and other deposit taking institutions will be able to use discount windows to meet liquidity needs.
In fact, since the Federal Reserve launched its bank term financing program, there have been constant doubts about banks using this tool for arbitrage.
For banks, the lower the BTFP interest rate, the greater the arbitrage opportunity. Institutions can borrow from this tool and then deposit the funds into the Federal Reserve's account, easily earning the interest rate difference with the reserve rate.
According to institutions, in the week ending January 17th, the funds used by banks through discount windows were only $2.3 billion, far below the historical high of $153 billion set in March last year. In contrast, according to data from the Federal Reserve, the amount of funds borrowed from bank term financing programs reached a record breaking $162 billion (approximately RMB 1160 billion) in the week ending January 17th.
Before the launch of the bank's regular financing plan, the Federal Reserve had always considered the discount window as a long-term solution to meet the liquidity needs of banks.
When will interest rate cuts be initiated?
What the global market is most concerned about is undoubtedly when the Federal Reserve will start its interest rate cutting cycle?
At present, the market unanimously expects that the Federal Open Market Committee of the United States will maintain interest rates unchanged for the fourth consecutive time at its first monetary policy meeting from January 30th to 31st.
The real focus of the market is the direction of interest rates at the Federal Reserve's interest rate meeting in March this year and subsequent meetings.
Recently, several Federal Reserve officials, on the eve of the silence period, countered market expectations for the Fed's interest rate cut of up to 150 basis points this year, intending to cool the market.
Among them, Federal Reserve Director Waller stated that with good economic activity and labor market conditions, the inflation rate is gradually falling to 2%, and there is currently no reason to take swift action or cut interest rates quickly.
His remarks have prompted investors to significantly lower their expectations for a rate cut in March.
In addition, Atlanta Fed Chairman Bostic stated that the worst outcome at the moment is that Federal Reserve decision-makers have lowered interest rates, but inflation has since risen, forcing them to raise interest rates again. He pointed out, "We don't want this kind of top-down or repetitive pattern to occur."
Former Federal Reserve staff member and economist Claudia Sahm believes that this idea may indeed prompt the Fed to postpone its first interest rate cut until May. She said that once the central bank starts taking action, it may happen soon.
In fact, history has also proven that the Federal Reserve should remain cautious when initiating interest rate cuts. In the 1970s, the Federal Reserve relaxed its policies prematurely before inflation truly subsided. Even Paul Volcker, hailed as one of the greatest chairmen in the history of the Federal Reserve, made such a mistake during the economic downturn in 1980.
According to Bloomberg, Joshua Schifflin, head of global trading strategy at Goldman Sachs, recently predicted that the Federal Reserve may cut interest rates four times this year; The US inflation rate will fall back to the Federal Reserve's set target of 2%.
Latest release from the United States
On the evening of January 25th Beijing time, data released by the US Department of Commerce showed that the actual GDP of the United States in the fourth quarter increased by 3.3% on an annualized quarter on quarter basis compared to the initial value, slowing down from 4.9% in the previous quarter but far exceeding market expectations of 2%. The US economy grew by 2.5% in 2023 and 1.9% in 2022.
Among them, personal consumption expenditure increased by 2.8% month on month, which is the main driving force of US economic growth. Business investment and housing also contributed to unexpected economic growth.
At the same time, the quarterly inflation data released, the PCE index, did not cool down again, and the personal consumption expenditure (PCE) price index increased by 2.8% year-on-year, slowing down from the previous value of 3.1%, but exceeding the expected 2.5%; The core PCE price index, excluding food and energy, increased by 2% on an annualized quarter on quarter basis, consistent with previous and expected values.
Analysts believe that a better than expected GDP may further delay the Federal Reserve's interest rate cuts.
Peter Cardillo, Chief Market Economist at Sparta Capital Securities, said that GDP data tells us that the US economy will enter a new year with strong growth, which is a good sign of a soft landing. Overall, this is a good report, but it may prompt the Federal Reserve to maintain interest rate stability at least until the third or fourth quarter of 2024.
In addition, according to data from CME's "Federal Reserve Watch", the probability of the Federal Reserve maintaining interest rates in the range of 5.25% to 5.50% in February after the release of GDP data is 97.4%, and the probability of a 25 basis point rate cut is 2.6%. The probability of maintaining interest rates unchanged by March is 58.4%.