So, a trader is sitting on a portfolio valued at USD1 million. Thirty percent of the portfolio is allocated to Treasurys; 25% to equities; 25% to gold; and 20% to real estate. They turn on their televisions and listen to an asset manager hustling her book that inflation is going to further whittle away at the income the trader derives from her portfolio. Like 90% of the asset managers that sell their wares on Bloomberg or CNBC, the trader is asked to keep their eyes on the next move of the Federal Reserve.
I understand the Federal Reserve is charged with not only managing the money supply but also with facilitating long term interest rates, maximizing employment, and managing stable prices, but at times I see an asset manager’s insistent focus on Federal Reserve System monetary policy as word salad probably repeated on a consistent basis since the Federal Reserve Act was modified in 1978 to reflect the dual mandate of stable prices and maximum employment.
The federal funds rate that asset managers want their clients to remain aware of is the rate assessed by banks to each other when lending bank reserves to each other. This rate is often referred to as the rate that sets a floor for other lending rates in the economy. I appreciate banks using some kind of reference rate as a floor for other rates, but an overnight rate for exchanging reserves to the consumer bears little relation to the act of a bank lending money to consumers.
For one thing, there is the counterparty risk. While banks do not need to bring collateral to an overnight loan with each other, consumers, with the exception of non-recourse loans, likely do.
A better reference rate, in my opinion, would be the interest on reserve balances, currently at 5.40%, where the Federal Reserve System pays a bank for parking excess reserves in a federal reserve bank master account or in the bank’s own vault. The bank has an option of keeping money back at 5.40% or putting that money to work at a rate above 5.40%.
Given the Fed’s aforementioned role as manager of the money supply and the impact on economic growth from a consumer not having loanable funds in their hands to spend, the interest on reserve balances, which influences whether money stays in the vault or flows out of the vault, seems more applicable.
Still, I would think that the asset manager would want the trader to focus on positive yield creating opportunities in a secondary market versus waiting on what happens in the overnight interbank market. The asset manager should want to expose the trader to actual activities that create product and income versus focusing on whether the interbank market is charging lower or higher rates for lending money.
Alton Drew
16 July 2024
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Lawyers Write the Bets. Bankers Sell the Bets. 