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12 17 2015 | by Victor Xing | Central Banks

Is it possible for Fed to lower rates in 2016, and how?

It is possible for the Federal Reserve to lower rates in 2016.  The current known catalysts include the following:
  • FED policymakers determine that disinflationary impacts from dollar strength and oil weakness is no longer transient, and inflation’s path toward  2% (measured in Personal Consumption Expenditures) will be longer and less certain
  • U.S. labor market conditions deteriorate and moving away from its currently near NAIRU levels
  • Financial conditions tighten significantly (due to policy or other factors)
    • A significant rise in short-term bond yield and long-term corporate borrowing cost
    • Sharp decline in equity valuation
    • Significant strengthening of the dollar
    • Widening of credit spreads
  • Economic conditions deteriorate in China (or more specifically, weakening China growth and no corresponding policy action from the PBOC)
  • Similarly, Eurozone growth weakens but ECB decides to keep policy on-hold
Mechanics of draining and injecting liquidity into the short-term market to raise and lower rates is as follows:
  • [Raising rates] The Federal Reserve is currently conducting the Overnight Reverse Repurchase Agreement (ON RRP) operations to drain liquidity from the financial market (and raising rates), by dedicating maximum $2 trillion assets (securities) from its balance sheet as collateral.  The New York Fed trading desk would sell these securities at the open market to qualified counterparties and pledge to buy them back at a higher price.  In this scenario, the FED is the dominant borrower willing to borrow at higher rates
  • [Lowering rates] If the FED decides to lower rates, the FRBNY trading desk (“the Desk”) will reverse the above scenario by conducting repo operations with counter parties (please see the below diagram).  Instead of selling securities, the Desk will act as lender, or cash provider, and offer to buy securities from banks, GSEs, and money market funds (thus providing cash to market participants), and the Desk will sell the securities back on the next day at a low rate.  In this scenario, the FED is the dominant lender willing to lend at a lower rate
Raise or lower rates via repo programs
Original Quora article

Next article12 17 2015 | by Victor Xing | Central Banks

What is FED’s mechanism to control interest rates?