Important paper on the Fed operating target from Lorie Logan, Dallas Fed President

 

Lorie Logan, the president of the Dallas Fed, gave an important speech called "The case for modernizing the FOMC’s operating target rate". I recommend it for anyone studying monetary policy and focusing on fixed income. It does not offer an immediate insight that generates wealth, but it provides a valuable glimpse into how the Fed may be considering new target rates and implementing policy. 

First, President Logan provides a good history of how the Fed's operating targets have changed over the last few decades. The Fed adjusts in response to structural changes in the market and the goals of the FOMC. Second, it explains why the current operating target is flawed, and third, it offers some solutions that can be implemented to make Fed policymaking more effective. Nothing is likely to happen in the short run, but this speech does provide insights into what changes may be coming down the road. 

Simply put, the current targeting of Fed funds is outdated because the current period of the Fed providing ample reserves means there is not a strong demand for borrowing and lending Fed funds. The market has shrunk with foreign banks being the primary borrowers, and FHLB banks serve as the chief lenders. The trading is a fraction of its former self. 

The key short-term rates are SOFR, which serves as a substitute for LIBOR, and tri-party repo, a deep and liquid market associated with borrowing and lending using Treasury collateral. One operating target is most effective, and Logan suggests a repo target may best serve the market. 

At some level, this may not change the overall mechanics of the short-term credit market, but it will provide a more effective signal and be a better representative of where short-term credit is trading.