Inside the Currency Market: Fed Minutes, What’s ahead, Fed Funds

Few interesting points from the Fed Minutes. The System Open Market Account or SOMA is the account used by the Fed to buy and sell bonds. The current account in thousands 4,213, 130, 992.20. Notes and Bonds 2,346, 581,744.20. The weekly change total was 11.4. On page 81 of Inside the Currency Market, I reported the figures for SOMA for July 7, 2010. In thousands, total SOMA 2, 054, 623, 672.5. Treasury Notes and Bonds 712, 023, 185.2. The weekly change was 163, 506.3. The Fed’s plan moving forward is to continue to replace maturing securities and not allow this account to fall. The vast majority of maturities replaced are found between the 2 -5 year.

The Minutes report the RRP is working as expected. And why not, its the Overnight Reverse Repurchase Agreement and created to steer the Fed Funds rate higher in 5 basis point ranges. This facility so far brought the FED Funds Effective rate from 0.04 to current 0.13. Its will be the method to see Fed Funds higher. The facility will go from Overnight to longer terms beginning at the end of the 2nd quarter.

Fed Funds will see a new calculation from a volume weigted mean to a volume weighted median.
More interesting is a new Bank Funding rate will be introduced next year. The Fed has been working on this project since the breakdon of Libor and its outlined in a paper. The new rate will be based on Fed Funds transactions and Eurodollar transactions for US banks. Note the line up of US interest rates. Headline 0.25, Fed Funds Effective, Libor, Repo. Then we begin pricing bond yields. Now we add another interest rate to the mix. Since the new rate will be used in Repos, my understanding so far and not exact is the new Bank Funding rate will be located between Libor and the Repo rate. What I see is US markets will slow. No longer will we see the volatility as we see today. Unless the Fed raises and distance exists between the various interest rates then volatility remains normal. I don’t see it because the central banks don’t want distance between rates. Its not so today and add another rate only compresses the distance between rates. The BOE is a good example.

Prior to 1996, the BOE worked on the Base Rate. That was the only rate available. To factor GBP/USD correctly, the Base Rate and USD headline and Fed Funds Effective calculated together. Then 1996, the BOE instituted a Repo rate. Then in 1997, Sonia was introduced. Today’s BOE line up is Base Rate, Libor, Repo and Sonia. The FED will have 5 rates to the BOE’s 4. The Eurozone will have 4 to the US 5. For G10 nations, the interest rate was employed purposefully to slow the speed and volatility of markets and exchange rates by closing interest rate gaps. For banks, its wonderful. For market volatility, its depressing. Interest rates follow each other in markets, they never create distance. Gaps in distance always close because interest rates are introduced with very close Standard Deviations Vs each other. Create 5 rates in US markets will only slow markets. Where would the BOE like to see GBP/USD prices. One month its 1.5800 then 1.5200 the next month. For the US, its different. The DXY trades in cents and its traditionally a slow mover. Add another interest rate, the DXY moves even slower. That should naturally slow the speeds and volatility of GBP and other currency pairs.

Note my list of important aspects to the Minutes. Its all about interest rates but further to control and fully manage the interest rate. Its the central banks way in the modern day as Keynesians control the ship. What’s the answer. Learn to trade pairs such as NOK, SEK, ZAR, TRY, RUB, NZD, AUD, INR, MXN. What;s the commonality? All nation use Repo Rates as their interest rates. Except AUD and NZD. Those pairs will always make traders money in good or bad times.

Brian Twomey Inside the Currency Market, btwomey.com

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