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Can the Federal Reserve effectively drain liquidity and push up interest rates?
The FED has been testing its ON RRP () as a tool to control the effective Federal Funds rate at times of policy tightening / rate hike.
Under ON RRP, the Federal Reserve sells securities currently held on the FED’s $4.2 trillion balance sheet to a wide variety ofwith an agreement to buy it back on the next business day with interest.
These transactions take cash away from the banks, GSEs, and money market funds, and in effect “drain liquidity” from the financial markets.
With the FED being the dominant borrower (willing to borrow at higher rates), banks, GSEs and money market funds have less desire to provide short-term funding for other entities, thus forcing them to borrow at the rate set by the FED.
Next article09 05 2015 | by Victor Xing | Capital Markets