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Funding liquidity in the American money market measures the difficulty of enterprises or financial institutions to obtain short-term wholesale financing in the money market. Generally speaking, if there is a financing liquidity problem and enterprises and institutions choose to sell certain financial assets in order to obtain “cash”, the market liquidity of the financial assets will drop significantly, and the asset price will also decline rapidly. Therefore, it can be said that financing liquidity is the basis of market liquidity.
The main body of the U.S. money market. We can understand the American money market as follows: financial authorities (short-term Treasury bills), dealers (whose financing needs mainly come from market making and financing clients such as hedge funds), and banks and money market funds are the main financing parties.
American Money Market: The Important Function and passive Position of the Federal Reserve. When the Fed acts as an importer of funds, the policy tools it uses are IOR and ON RRP. Both instruments are initiated by counterparties, which voluntarily deposit excess “money” with the Fed. When the Fed acts as a lender, it is in effect fulfilling its lender-of-last-resort obligations. As long as banks provide collateral as required, the Fed will lend money to banks at the discount window rate (DW). In July 2021, the Federal Reserve established a new standing Repurchase Facility (SRF), in which the Fed will lend funds in the repo market at the lowest SRF rate, provided that collateral requirements are met.
Supply and demand of financing liquidity: Financial authorities (short-term Treasury bonds), dealers (whose financing needs mainly come from market making and providing financing for clients such as hedge funds), and banks (general HQLA asset +FHLBs) and money market funds are the main lenders. For HQLA portfolios and money market funds, the main lenders, there are generally three asset options: lending to the Treasury (buying U.S. Treasuries), borrowing through the repo market, or lending to the Federal Reserve, but at different rates in the latter two markets. Bank HQLA portfolios in the Repo market borrow money at the general collateral repurchase rate (GC Repo). Money market funds borrow money in the Repo market at a rate known as the tri-party Repo. The rates at which they lend to the Fed are IOR and ONRRP, the two policy rates at which the Fed controls the overnight interest rate market.
Soul of US money Market: How to observe liquidity tightness? If money market funds use the Fed’s overnight reverse repurchase facility, there are no better assets to choose from, and the needs of major financiers have been met. It should be pointed out that the absolute amount of reserve does not reflect the tightness of the money market liquidity. The rise in reserve requirements is also likely to be a tightening of liquidity in the money market. We need to look at the use of the Fed’s reverse repurchase facility to judge money market liquidity.
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