The arsonist has lost control of the fire.
While the rest of the world is distracted by the plummeting unemployment rates and trade deal hype, a funny (well not so funny) thing happened in the short-term funding markets in the world’s reserve currency.
As we noted previously, something unexpected has been going on in overnight funding markets: ever since March 20, the Effective Fed Funds rate has been trading above the IOER. This is not supposed to happen.
As a reminder, ever since the financial crisis, in order to push the effective fed funds rate above zero at a time of trillions in excess reserves, the Fed was compelled to create a corridor system for the fed funds rate which was bound on the bottom and top by two specific rates controlled by the Federal Reserve: the “floor” for the corridor was the overnight reverse repurchase rate (ON-RRP) which usually coincides with the lower bound of the fed funds rate, while on top, the effective fed funds rate is bound by the rate the Fed pays on Excess Reserves (IOER), which served as the corridor “ceiling.”
Or at least that’s the theory. In practice, the effective FF tends to occasionally diverge from this corridor, and when it does, it prompts fears that the Fed is losing control over the most important instrument available to it: the price of money, which is set via the fed funds rate.
This week, The Fed tried to do something about it by cutting the IOER.
It has failed!
The effective fed funds rate fell to 2.41% on Thursday from 2.45%, according to New York Fed data….