Pricing the global dollar
The Fed sets a global outside spread
A couple of weeks ago, I looked at the Fed's creation of two new standing facilities as part of its administration of the global dollar. The new lending mechanisms, the standing repo and FIMA repo facilities, along with the existing facilities, the Treasury General Account and the FX swap lines, are all mechanisms for adding dollar reserves to the payment system. To complete the picture, we should add the Fed's two other standing facilities, which drain dollar reserves.
Repo facilities for draining reserves
The overnight reverse repo and the FIMA overnight reverse repo facilities have already been in heavy use, a consequence of the central bank's balance sheet expansion (i.e., quantitative easing) stance over the course of the COVID-19 pandemic. The Fed acts as a borrower in both cases; the transaction is conducted in the repo market in both cases. These T accounts show, above the double line, the two facilities as they are recorded on the Fed's balance sheet. Because they are repo transactions, there is also collateral flow. The Fed does not record these on its balance sheet, but I have done so, below the double line:
The two own-issuance facilities (as I have labeled them), the TGA and the FX swap lines, also absorb reserves, though in a different way. Both the Treasury General Account and the FX swap lines provide USD dollar reserves using the depositors' own liabilities as collateral. For the TGA, this collateral takes the form of Treasury securities; for the swap lines, reserve deposits at other central banks. Because the collateral is a liability to the depositor, there is no need for a special mechanism to absorb reserves: the depositor can always absorb reserves simply by cancelling them against its collateral.
Both sides of the market
This analysis arranges the standing facilities into a nicely symmetrical picture:
There are three dimensions: adding vs. absorbing reserves; domestic vs. international, and own-issuance vs. repo. All eight possibilities exist, though as I have shown, the mechanics are not perfectly symmetrical.
Pricing the global dollar
How are all of these mechanisms meant to work together? The way that the facilities are priced suggests an initial interpretation, though experience over time will be more informative. Closest to zero are the reserve-absorbing reverse repo facilities, priced since June at 5 basis points. Money markets have been stuck to this floor since then. The reserve-adding mechanisms are intended for a post-QE future, in which reserves sometimes need to be borrowed. They are priced at 25 basis points, above current money-market rates.
The intention is for normal money-market prices to be set by private dealers, with recourse to the standing facilities being the exception not the norm. The Fed will make an outside spread, that is, while private dealers make a narrower inside spread. The standing facilities will ensure that when private market-making breaks down, a lot of liquidity is available just at the edges of the corridor.
In this Treynor diagram, I think of private money market dealers establishing a price along the sloped, dashed inside spread lines. When their position reaches its max long limit, i.e. when money markets have lent as much as they can, they will have to borrow reserves from the Fed at the SRF rate. Similarly, when money markets have borrowed as much as they are willing, they can offload any excess by depositing at the Fed at the ON RRP rate.
I have shown the FX swap lines as being priced even further out. There is an important ongoing conversation on the international dealer of last resort function. Building that connection will have to be work for the future.