A Layperson's FAQ on Chevron Deference

Between Supreme Court decisions and the presidential debate, it's been an exciting few days. Predictably, nowhere has the reaction to these events been more unhinged than on Twitter. My own feed is dominated by dog Twitter, the internet hall of fame, and the comic genius behind the Oklahoma Department of Wildlife Conservation account (who just announced she is moving on, breaking the hearts of tens of thousands of her devoted fans). Still, some law content leaks in because I'm a closet SCOTUS (Supreme Court of the United States) junkie, and it's been ... what's the opposite of enlightening? 

So here we go, a layperson's FAQ on Chevron deference. The usual caveat applies: I am not a lawyer, I have never been to law school, and any mistakes or misunderstandings are entirely my own. 

What was the recent SCOTUS decision?

In what was arguably the most consequential decision to date of the current term, the court ruled in Loper Bright v Raimondo to overturn the Chevron doctrine, in a 6-3 vote along ideological lines. This doctrine, also referred to as Chevron deference, was a standard established by SCOTUS forty years ago in their opinion to Chevron v Natural Resources Defense Council (1984).  

Yeah, so far that's not helping

Three branches of government: legislative, executive and judicial. 

The legislative branch (Congress) writes laws and federal statutes. Congress also creates administrative agencies that are granted the authority to implement and enforce these statutes. 

The agencies, whose heads and executives are appointed by the executive branch (White House), interpret the statutes to write rules, regulations, conduct enforcement and impose penalties for violations of the laws and statutes. 

The Administrative Procedures Act (APA), which Congress enacted in 1946, "serves as a check upon administrators whose zeal might otherwise have carried them to excesses not contemplated in legislation." The APA gives the judicial branch a role in policing the statutory boundaries. Federal courts are directed to "set aside agency action" that is "not in accordance with law" or "in excess of statutory jurisdiction, authority or limitations". 

Ok, School House Rock. What was Chevron deference?

Chevron was a doctrine, created by SCOTUS in their 1984 opinion, that outlined a two-step framework for determining whether or not the court should apply its own interpretation of a statute, or defer to the agencies' interpretation, when the agencies' scope of authority or interpretation is challenged through litigation. 

From Chevron Deference: A Primer (2023) by the fiercely nonpartisan Congressional Research Service (excerpts from page 2 of 35, edited for brevity, emphasis added): 

When Congress delegates regulatory functions to an administrative agency, that agency’s ability to act is governed by the statutes that authorize it to carry out these delegated tasks. In the course of its work, an agency must interpret these statutory authorizations to determine what it must do under the statute and what it may do within the limits that Congress has set. When agencies act pursuant to those interpretations, the scope of their statutory authority is sometimes tested through litigation. Courts that review challenges to agency actions may give special consideration to agencies’ interpretations, particularly of the statutes they administer. This special consideration is known as “deference.” Whether and when courts should defer to an agency’s interpretation of a federal statute, rather than apply the court’s own interpretation, are critical questions in administrative law and judicial review of agency action. 

The Chevron framework of review usually applies if Congress has given an agency the general authority to make rules with the force of law. Within that framework, Chevron often requires courts to accept the statutory interpretations that underlie the agency’s implementation of that general authority. Where a statute is susceptible to multiple reasonable interpretations, the Chevron framework requires courts to defer to an agency’s reasonable interpretation of the statute. The Chevron framework, accordingly, shifts interpretive authority from the federal courts to agencies in certain circumstances. 

 

If Congress has delegated authority to the agency to decide a question—that is, if Chevron applies—a court asks at step one whether Congress directly addressed the precise issue before the court, using traditional tools of statutory construction. If the statute is clear on its face with respect to the issue before the court, the court must implement Congress’s stated intent.

 

If a statute is silent or ambiguous with respect to the specific issue, the court then proceeds to Chevron’s second step. At step two, courts must defer to an agency’s reasonable interpretation of the statute. Courts employ a variety of tools to determine whether an agency’s interpretation is reasonable, including some of the same interpretative tools used in the step one analysis. 

The Primer is outstanding and worth reading in its entirety. 

Seems reasonable. What became problematic? 

Over time using the Chevron framework became messy. From the Primer:

Application of the Chevron doctrine in practice has become increasingly complex. Courts and scholars alike debate which types of agency interpretations are entitled to Chevron deference, what interpretive tools courts should use to determine whether a statute is clear or ambiguous, and how closely courts should scrutinize agency interpretations for reasonableness. A number of judges and legal commentators have even questioned whether Chevron should be overruled entirely. 

In later decisions SCOTUS modified it, blurred it, side-stepped it and created exceptions to it. Still, it was heavily utilized for about 40 years and has been cited in 18,000 opinions across all federal courts (see here and here). However, SCOTUS itself hasn't utilized the Chevron doctrine in a decision since 2016. Legal scholars and court watchers have long referred to Chevron as a zombie precedent, with Justices Alito and Gorsuch stating outright in comments from 2022 that it should be overruled (see the Primer, pages 20-21 of 35). 

Part of the complexity was because government agencies, typically at the direction of the executive branch, also began to write new rules, or (at times wildly) broaden interpretations of their authority in a way that took advantage of a statute being "silent or ambiguous" with respect to an issue. In certain cases an agency's rules and interpretations would change with each turnover in the executive branch. 

I'm shocked! The administrative state = the deep state? 

That's certainly what all the celebrations and hysteria on Twitter would lead one to believe. There's a good article on The Verge here that summarizes some possible areas of impact now that Chevron has been overturned. They mention:

• The FCC's regulations covering broadband and net neutrality; 
• The EPA's rules for carbon emissions and greenhouse gases, and 
• The FTC's regulation of big technology companies. 

It's worth noting that despite the "OMG this is such a power grab by SCOTUS" statements at the beginning, most of the experts that they cite in each case state that Chevron has been dead for some time and the court has migrated to using the Major Questions Doctrine as its standard for adjudicating similar questions of statutory interpretation. 

The what? And this better be short because I'm running on fumes.

As SCOTUS found the Chevron framework problematic, it began to augment or replace it with what is now referred to as the Major Questions Doctrine. From the Congressional Research Service primers for both Chevron and Major Questions:

Under the Major Questions doctrine, the Court has sometimes declined to defer to an agency interpretation under Chevron in “extraordinary cases” that present an interpretive question of great “economic and political significance.”

Applications of the doctrine rest on a determination by the Court that one of the core assumptions underlying Chevron deference—that Congress intended the agency to resolve the statutory ambiguity—is no longer tenable. Where major questions are at stake, the Court has said, “there may be reason to hesitate before concluding that Congress ... intended” to delegate resolution of that question to the agency. The Court’s hesitation is reflected in survey data of congressional staffers. Of the 137 staffers surveyed, 60% responded that drafters intended Congress—not agencies—to resolve major questions.

In several recent decisions, the Court has placed increasing emphasis on the major questions doctrine. First, in Alabama Association of Realtors v. HHS, the Court explained that the CDC’s eviction moratorium was of major national significance and required a clear statutory basis because the agency’s action covered 80% or more of the nation; created an estimated economic impact of tens of billions of dollars; and interfered with the landlord-tenant relationship, which the Court explained is “the particular domain of state law.” Then, in National Federation of Independent Business v. OSHA, the Court considered OSHA’s emergency temporary standard (editor: requiring that workers be vaccinated against Covid-19) to be of major economic and political significance because, in its estimation, it seriously intruded upon the lives of more than 80 million people.

Most recently, the Court’s decision in West Virginia v. EPA marked the first express reference to the major questions doctrine in a majority opinion of the Supreme Court. In West Virginia, the Court rejected EPA’s reliance on a statutory provision that, in the Court’s view, was a “previously little-used backwater.” The Court concluded that it was unlikely Congress would task EPA with “balancing the many vital considerations of national policy implicated in deciding how Americans will get their energy,” such as deciding the optimal mix of energy sources nationwide over time and identifying an acceptable level of energy price increases. For more information on the case, see CRS Legal Sidebar LSB10791, Supreme Court Addresses Major Questions Doctrine and EPA’s Regulation of Greenhouse Gas Emissions, by Kate R. Bowers. 

All of the cases cited above were ones where the government agencies arguably went well beyond their statutory power to undertake actions at the direction of the executive branch. 

What are the takeaways? 

Chevron has been a zombie precedent for close to a decade. Legal scholars, experts and serious court watchers have been expecting this for awhile. Depending on ideology, this can be interpreted as a shift back towards more balanced judiciary oversight of the executive and administrative branch, an exhortation for the legislative branch to start writing less ambiguous and clearly defined statutes, or "a massive power grab" by the Supreme Court. Over time it could have significant ramifications for how these cases are decided, particularly in lower courts, but that's been underway for several years. 

Hysteria aside - and there's been a lot of it - Chevron being overturned will probably stand as the most consequential decision of this term*. 

*The presidential immunity decision is tomorrow. And then come the fireworks! Har har. 

Only Rants

Instead of restarting this blog, which has long focused on finance related topics, I briefly considered starting a new blog and calling it "Only Rants". The title was catchy, though admittedly stolen from my nephew Rand, who at one time considered calling his college football blog "Only Rands". It also implied articles that were grouchy with a twinge of inappropriate, which *points to self* seemed to be on brand. But I finally decided against it for several reasons. Although I will no doubt include occasional spirited content, I want to focus on constructive analysis and ideas more than complaints. I  also worried about the side traffic and judgement that name might attract and I'm not dealing with that. 

However, it's Sunday afternoon and I can't resist a post of random rants. Serious, thoughtful, mind-stretching topics are for weekdays. 

Quick Hint Rants

So boring I'm waiting for your scenes to be over  

Typically this is a combination of the part or scene being badly written, the character under developed, and the actor not finding a way to overcome the deficits with more nuanced acting. 

• Zendaya in Dune Part II - The character isn't interesting, which is entirely the fault of the writers. Zendaya is not particularly convincing that she feels anything other than annoyance, and perhaps jealousy, towards Paul. The pouting and stomping off towards the end comes across as childish, which I hate, because if she's supposed to be strong and powerful, make her exit powerful and principled, not kind of pathetic. 

• Francesca in Bridgerton, Season 3 - I know the point of her love story is that it's not all fireworks and lust (at least not for her husband, haha), but the character and the actor are so flat that it's impossible to care what happens. So far these were the only scenes in three seasons that I fast forwarded through so I wouldn't have to watch her smile wanly. 

Badly miscast and it's still bugging me

• Peeta in Hunger Games and Tom Cruise as Jack Reacher - Just, no. In the books Peeta is big, strong and physically intimidating. Jack Reacher is a former military, Rambo type with the size and build of my ex-husband (6'6", long ape arms, makes anyone think twice about messing with him). As actors both of them are fine, but the characters size and physicality is an integral part of the stories. Josh Hutcherson is 5' 5" and looks like Jennifer Lawrence could beat him in a bar fight. I still enjoy the movies and he does a fine job, but it nags at me that I can't get past his description in the book, which is absolutely a limitation of mine. Tom Cruise casting himself as Jack Reacher was pure hubris and thank god they've redone the series with an actor who is actually believable in the part. 

• Dana Delaney in Tombstone - Tombstone is one of my favorite movies. It has the holy grail of male actors: Val Kilmer (he should have won the Oscar for this performance), Kurt Russell, Sam Elliott and Bill Paxton in the leads. Michael Biehn, who I worship from his turns as Reese in Terminator and Hicks in Aliens, also plays Johnny Ringo. I suspect some of Ringo's scenes ended up on the cutting room floor, because despite a strong performance, the character doesn't feel as fully developed as some of the others. Wyatt's wife, Mattie, has a small, underwritten part (women in a western, duh) but Dana Wheeler still manages a scene stealing performance. I can't put my finger on what bothers me about Dana Delaney's portrayal, but she looks and feels out of sync with the rest of the cast. It's almost as if her performance is modern and everyone else is sticking to old west period acting. It doesn't ruin the movie by a long shot, but it's an out of tune note in an otherwise wonderfully harmonious ensemble. 

No one has a photographic memory

Good Will Hunting was total nonsense. So was Suits. All of the (invariably male) Hollywood written genius characters, astonishing people with near instant recall, reciting limitless passages verbatim because they "have a photographic memory" for ostensibly the library in their heads. It's bunk. 

Scientists have studied and tested this for decades. People who claim to have photographic memories are invariably incorrect or lying. Those closest to having photographic memories tend to recall events or visual information with exceptional detail accurately, not written information. 

Of course there are people with exceptional memories (of whom I am deeply jealous); and many more who build, flex and improve their storage and recall of information with practice. The sheer amount of information that you have to memorize and retain to make it through medical school convinced me I could never be a doctor. Well, that and I can't stand being around sick* people. "Be a pathologist!" *or dead people. 

Jobs I Should Have

 I am currently, as they say, "between jobs", and have been giving some serious and some not at all serious thought to work that I am particularly well suited to do. These are my not at all serious thoughts, in that no one would hire me to do these jobs, and some of these jobs don't technically exist, but I believe they should and that I might be the best person to do them. 

1. Editor for the Harry Potter book series

JK Rowling is an amazing story teller. The language she uses is inventive, the worlds she creates are truly magical and immersive, and she does an exceptional job developing her characters as they mature from middle school through young adulthood. 

JK Rowling is not the best writer. I gave up on reading the books about midway through Goblet of Fire because OMG she just blabbers on and on. She indulges in 50 page tangents and background about characters that go nowhere and don't enhance the story line. Her sentence structures at times are chaotic. Much like Stephen King, she tends to fall back on tropes throughout the series, some of her own creation and some that are exhaustingly stereotypical, particularly in the doofus persona of Ron and the brilliant bookworm Hermione. 

The excessiveness needs editing down, the sentence structures could be tightened up in areas, and some material needs to either be pushed into other standalone books or simply dropped. If you've ever read an interview of Jodie Foster, they can be mind numbing because the woman seems to never shut up. She is wildly successful, her career is productive and challenging, and yet she's so enchanted by her own persona that its off putting. In some limited aspects JK's writing strikes me that way. It's a weird sort of narcissism not to temper your own thoughts, writings or production, as if restraint were only for the less accomplished. 

My most significant gripe with the storytelling itself - not the job of an editor, but I'm going to mention it anyway - is that she repeatedly kills off characters either to seemingly manufacture drama or because she doesn't know what to do with them and wants to focus on new ones. And then she introduces new ones and kills them off too. The stories are fabulous and they follow wonderful arcs. But take a lesson from Tolkien and keep most of the good guys alive. Don't ask your readers to invest deeply in a multitude of characters that you gradually exterminate to presumably reinforce your main characters isolation. That's a bit cheap. 

2. Editor for the Harry Potter movies

Ok now I'm really mad. A badass female author who turned over her incredible stories to all male directors (and screenwriters, I believe), one of whom had never even read the books, and it SHOWED. Mike Newell, Goblet of Fire, by far the worst, most discombobulated movie of the series. He has been eviscerated in other reviews but he deserves it. What kind of arrogant jackalope even wants to direct a movie based on a book that he doesn't find interesting enough to read?  

The movies severely edit down the books, which of course they have to, and most of them do it exceptionally well. I would honestly love to see a Netflix series of the books that can be more expansive and include more storylines, like a Stranger Things style treatment. What bothers me is that Hermione is frequently made a nagging shrew in several of the movies, which to my limited knowledge she very much was not in the books. Include Women Directors, you freaking sexist jerks. 

Best movie of the series and arguably best book of the series: Prisoner of Azkaban. 

Best scene added by writers and director David Yates: where Harry and Hermione dance in the tent to 'O Childern' by Nick Cave, in Deathly Hallows part 1. Everyone seems to love that scene, it captures the deep friendship and intimate connection between Harry and Hermione, and it lifts the story out of the relentlessly, interminably bleak sequence (that I've heard lasts for 300 pages) in the book where nothing much happens. Ok, sorry, moving on. 

3. Dog chiropractor and masseuse 

This is my next career. Not kidding. I love dogs. I'm not a great dog trainer, though I plan on learning how to be a decent one. But helping dogs feel better, move better, relieve stress and pressure on their joints and muscles is definitely something I want to become outstanding at. 

4. Residential architecture and interior design critic

This is one of my favorite hobbies. Just ask my siblings, to whom I email house listings from Zillow, the Wall Street Journal real estate section, or links to various architecture or design sites along with many paragraphs of commentary that bores them silly. 

The reason I could never pursue architecture or design as an occupation is that I have laughably poor depth perception, seek out adult versions of garanimals because I can't match colors, put together complimentary patterns or styles, and although I'm trying, I have near zero ability to pull together a fashionable outfit much less a subtle, balanced, coordinated interior space. 

However, I've learned that TONS of people - including some builders and interior designers - are equally inept at these skills and have jobs doing them anyway, and I enjoy making fun of them. "Well Mary Beth, that's not very nice." Really? You're here so I assume we've met. 

The woman who writes the McMansion Hell blog is one of my personal heroes. She is an architecture expert and in addition to being hilarious, you learn things from her analysis about why some houses look like unbalanced battleships and others have the timeless grace of Biltmore House. 

Hat tip: the most atrocious houses in the Wall Street Journal real estate section are built by small business owners or builders who "have a passion for architecture" and the interiors were designed by (typically) their wives. Invariably it took the couple 7 years to build, they spent $7 to $20 million on the house, its a jumbled mess that often incorporates every overwrought design trend of the past 15 years, and they've lived there for 3 to 5 years and are now selling because "the kids are grown and our business increasingly takes us to Europe for several months of the year, so we're looking for a pied a terre in Paris." I would write the articles but I worry I couldn't sufficiently dampen a slight undertone of sarcasm. 

Those are some of the jobs I should have, while I continue looking for a job that I need, and am actually good at. Was this a TED talk? I honestly have never listened to one. 

Fed Projections for the Fed Funds Market Implies Additional Tightening

Earlier this week (on Tuesday, February 27, 2018) researchers at the Fed published a paper, inauspiciously titled A Model of the Federal Funds Market: Yesterday, Today and Tomorrow. The authors develop a quantitative model of the fed funds market –honestly one of the best and by far the most comprehensive that I’ve seen – and project changes in future trading volumes and levels of the fed funds rate. The dynamics are not based on the pace of fed funds rate hikes themselves, though they do assume hikes proceed along the Fed’s baseline. Instead, the model projects the level of the effective Fed funds rate relative to the target as the Fed undertakes policy normalization and aggregate outstanding reserves – excess cash in the banking system – are drained by the Fed, declining from roughly $2 trillion to $200 billion.

This reduction – or normalization - of the level of reserves is expected to gradually reshape the interbank market, raising the trading level of the effective fed funds rate above the upper bound of the fed funds target, due to increased trading volume and an increase in the number of participating banks. The return of bank trading activity will supplant the current domination of the fed funds market by the GSEs. These projections, if realized and supported by the FOMC as prudent policy, obviously have important implications for a variety of short term interest rates and spreads, including those for repo, overnight index swaps (OIS), Libor and its descendants, the overnight bank funding rate and commercial paper.

Key Takeaways

·         The authors project that large banks will return to lending in the fed funds market when the level of reserve balances falls to $900 billion.

·         At the current pace of policy normalization, reserve balances are expected to reach $900 billion in January of 2021. Fed projections of SOMA holdings and the level of reserve balances can be found here.

·         The baseline projection is that as total reserves pass through the $850 to $800 billion range, trading volume in fed funds increases and the effective fed funds (EFF) rate begins trading above the interest on reserves (IOR) rate, which is set at the upper end of the fed funds target range. This rise in the EFF rate relative to the target should happen in February / March of 2021 timeframe.

·         By December 2021, when aggregate reserves fall by another $400 billion, the model projects that the EFF rate will be sloping upwards to the midpoint between the upper bound of the FF target range and the discount window lending rate, which is set 50 basis points above the upper bound of the target.

·         That implies the EFF rate will float from 8 bps below the FF target to 25 bps above it, tightening short term interest rates by an additional ~33 bps as the Fed proceeds with policy normalization and reserve balances decline. This additional move higher in the EFF rate would presumably occur gradually throughout 2021.  

Excerpts from the paper

Caveat: I would strongly recommend reading the entire paper, as it is a terrific analysis and includes much more detail and nuance, as well as confidence intervals around their model projections, than I can cover here. Emphasis added.

For our main policy exercise we trace the evolution of the FF market as we reduce the aggregate supply of reserves from its current levels down to $200 billion Doing so requires us to specify the complete dynamics of the distribution of excess reserves across banks along the path, for which we have little more than an educated guess. For our baseline case we find that the banks with the largest balances return to lending funds at around $900 billion in total reserves, driving a resurgence in FF volume. Quite quickly the EFFR drifts above the IOR—somewhere between $800 billion and $850 billion—as bank-to-bank trades necessarily execute at rates above the IOR. This is an important event, as it marks the end of the current implementation framework that equates the IOR to the top of the target range for the EFFR. However, it takes about $400 billion less aggregate excess reserves for the EFFR to start sloping upward to the midpoint between the IOR and the discount-window rate—what would be the hallmark of a classic corridor system.

We find that the evolution of the FF market is quite sensitive to the dynamics of the distribution of excess reserves across banks. In particular, the extent to which the largest banks hoard reserves is crucial to determine when the EFFR crosses above the IOR. By varying the rate at which the banks with higher balances reduce them relative to those banks with lower balances, the EFFR first drifts above the IOR anywhere between $500 billion and $1.1 trillion. Of particular interest is the possibility that the largest banks plan to rely on reserves as high-quality liquid assets to satisfy regulations. If so, the distribution of reserves becomes more concentrated at the top, and mechanically there is a larger fraction of banks with low balances. This combination increases the gains of trade and leads the largest banks to lend funds at a higher level of aggregate reserves, driving the EFFR above the IOR much sooner than under the baseline.

Refresher on Fed’s Monetary Policy Rates

Secured lending to the Fed

Ø  Safest counterparty (the Fed) + safest collateral (Treasuries) = Lowest return on investment

Overnight Reverse Repurchase rate (ON RRP) – Interest rate offered by the Fed for overnight loans, with borrowed funds secured by Treasury collateral from the Fed’s SOMA portfolio. These borrowings of cash in exchange for collateral are categorized as open market operations by the Fed, and they temporarily drain reserves from the financial system. Eligible counterparties include primary dealers, banks, money market funds and the GSEs. The offering rate is set at the lower bound of the FF target range, though it can fluctuate in certain circumstances based on demand (see additional notes); currently 1.25%.

Borrowing unsecured in the US based interbank market, e.g. the Fed funds market

Ø  A US bank borrowing from another US bank or GSE, to meet the level of cash reserves depository institutions are required to hold in their accounts at the Fed. Roughly speaking, these required reserves are 10% of a bank’s transaction deposits.

Ø  Prior to QE and LSAPs the level of excess cash in the system was structurally low, so the Fed funds market was very active and liquid. The Fed conducted daily open market operations as a lender of cash to keep the effective interbank borrowing rate close to their Fed funds target rate. These were overnight and short term repurchase (repo) operations.

Ø  As the Fed normalizes monetary policy they will gradually reduce their portfolio of Treasury and agency securities, and will conduct reverse repo operations, both of which will drain excess cash reserves from the banking system.

Interest on Reserves (IOR) rate – Interest rate paid by the Fed to depository institutions for reserves held in their account at the Fed. Set at the upper bound of the target FF range; currently 1.50%.

Ø  Pointing out the obvious (because I’m great at it) – since a depository institution can leave their cash in their reserve account at the Fed and earn the IOR rate, there is no incentive for that bank to lend money to anyone at a lower rate.

Ø  The reverse is also true. If a bank can borrow funds from another institution at a rate below the IOR, they can park those funds in their account at the Fed and earn the difference. A nice risk-free arbitrage.

Ø  In theory the IOR sets a lower bound for unsecured interbank lending rates. In practice it’s imperfect, due to (a) regulatory charges imposed by the FDIC; and (b) the participation of the GSEs in the interbank market. The GSEs are not required to hold reserves at the Fed, so cannot earn the IOR rate on their excess cash.

Ø  The GSEs will therefore lend cash in the interbank market at rates below IOR, and banks will execute the arbitrage. In times of abundant reserves – post QE and LSAPs – these lending operations dominate the interbank market, pushing the effective Fed funds rate below the upper bound of the target.

Target Fed funds rate (FF) – Fed’s monetary policy target range for overnight interbank lending. Difference between lower and upper bound set at 25 basis points; target adjusted in 25 basis point increments (e.g. +/- 25 bps, +/- 50 bps); current FF target range is 1.25% to 1.50%.

Effective Fed funds rate (EFF) – Calculated as the volume weighted daily median borrowing rate where reserves actually trade in the US based interbank market. This trading data is reported by depository institutions, and collected and published by the Fed.

Ø  The FF target range is currently 1.25 – 1.50%, and the effective FF rate – with the exception of days which are on month-end – typically trades 8 bps below the upper end of the target. Right now that means the EFF rate is trading steadily at 1.42% with daily trading volume in the range of $80 to $100 billion. You can find complete details here.

Financial institutions borrowing funds from the Fed, secured by a wide range of collateral

Discount window lending rate – The rate the Fed charges eligible institutions to borrow money from the Fed on a secured basis, where a very wide range of collateral is accepted. Borrowing from the Fed at the so-called discount window for large institutions is generally seen, and meant to be, a measure of last resort. There are smaller banks and financial institutions which engage in typically seasonal borrowing from the discount window, which is not an indication of stress. The discount window rate is set at the upper bound of the target Fed funds rate + 50 basis points; currently 2.00%.

Technical note: The GSEs (Fannie Mae, Freddie Mac, the Federal Home Loan Banks, et al) are not eligible to earn IOR on their excess cash because these organizations are not depository institutions. Their participation in the Fed funds market is one-sided as they enter only as lenders of funds to depository institutions (banks), not as borrowers. Because the GSEs (a) cannot earn IOR from the Fed; and (b) do not owe depository institution insurance fees to the FDIC, they are willing to lend their excess funds at rates below IOR.

Tracking the Fed’s Integrity

Preamble

By now every financial market participant and pundit with a pulse expects the FOMC to raise interest rates at its meeting on March 15th, 2017. The FOMC is finally executing on a plan for gradually normalizing interest rates that was outlined and initiated in December 2015, then promptly abandoned. Whether the FOMC was suffering from a collective form of economic attention deficit disorder, paralyzed into inaction by the potential impact of political events in Europe and the US, or simply nodding off at the rate switch, the dithering badly eroded their credibility. The conveniently hawkish reversal post-election has now cast doubt on their integrity. 

Here we provide a backwards prospective of FOMC decisions, from Dec 2015 through Dec 2016, as reasoned in the FOMC press conference transcripts. The progression from "we're finally ready to do this, baby steps!" to the FOMCs attempt at a Jedi mind-trick, "monetary policy magically tightens because we lowered our pretend target" is worth the review. Unfortunately, it calls into question the monetary policy objectivity of this FOMC, which continues to emphasize political or financial market gyrations ahead of its mandate. 

Why We Focus on FOMC Meetings with Press Conferences

There are eight regularly scheduled FOMC meetings per year (FOMC meeting calendars, statements and minutes ) spaced approximately six weeks apart. In March 2011, then-Chair Ben Bernanke announced that he would begin holding quarterly press conferences after FOMC meetings, in order to “further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication.” In theory, the press conferences - which occur every other meeting - should impact neither the timing or pace of FOMC decisions to raise or lower rates. In reality, financial market participants and Fed watchers quickly presumed any substantive shift in the stance of monetary policy would only occur at “live” meetings, when the Chair has the opportunity to elaborate on (or perhaps justify) the FOMC’s decision during the press conference. Although FOMC members have murmured from time to time that meetings without press conferences scheduled should still be considered “live”, in fact no significant change or communication regarding monetary policy or the FOMC’s economic outlook has since occurred at a meeting which is not followed by a press conference.

The FOMC also releases an updated version of its Summary of Economic Projections (SEP) at each regularly scheduled meeting which is followed by a press conference. The SEP contains summary data of FOMC members economic forecasts, including:

·        Changes in real economic growth (GDP);

·        The unemployment rate;

·        Inflation, as measured by personal consumption expenditures (PCE) and core PCE; and

·        Projections for the appropriate path of monetary policy - the level of the fed funds target rate –consistent with their economic outlook. 

Objectives of Monetary Policy

Excerpts from a Federal Reserve Board FAQ titled, What are the Federal Reserve's Objectives in Conducting Monetary Policy? (edited for brevity):

The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act.

The FOMC judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve's statutory mandate.

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the job market. These factors may change over time and may not be directly measurable. In the FOMC's December 2016 Summary of Economic Projections, Committee participants’ estimates of the longer-run normal rate of unemployment ranged from 4.5 to 5.0 percent and had a median value of 4.8 percent.

Two objectives of monetary policy: The Fed has long interpreted its statutory objectives for monetary policy as a dual mandate for (1) maximum employment and (2) low inflation ( = stable prices + moderate long-term interest rates).  

Not an objective of monetary policy: Everything else. That includes stoking or impeding US economic growth, global economic growth, fiscal policy, tax policy, the integrity or stability of the financial markets (which arguably falls under the Fed’s regulatory objectives and mandate, but not its monetary policy objectives), fretting about the Brexit vote, the Greek debt crisis, performance of the equity markets, or the volatility of the foreign exchange markets. Just to name a few.

FOMC Meeting of December 16, 2015 – liftoff.

The FOMC finally begins what is billed as a gradual tightening of monetary policy, and raises interest rates from the “zero lower bound.” The FOMC increases the target fed funds rate from a range of 0% to 0.25%, to a range of 0.25% to 0.50%, and the IOR rate in tandem from 0.25% to 0.50%. The median forecast of FOMC members, as released in the Dec 16 2015 SEP , projects the appropriate path of monetary policy would lift the upper bound of the fed funds target range by 100 bps, to 1.50% by year-end 2016 and 2.50% by year-end 2017, assuming their economic forecasts are achieved.

Throughout this piece the indented text are excerpts from Chair Yellen’s remarks from various FOMC press conference transcripts (edited for brevity, formatting and subheadings added for clarity, emphasis mine):

Overview

This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression. It reflects the Committee’s confidence that the economy will continue to strengthen.

Room for further improvement in the labor market remains, and inflation continues to run below our longer-run objective.

The process of normalizing interest rates is likely to proceed gradually, although future policy actions will obviously depend on how the economy evolves relative to our objectives of maximum employment and 2 percent inflation.

Unemployment and GDP

The unemployment rate, at 5 percent in November, is down 0.6 percentage point from the end of last year and is close to the median of FOMC participants’ estimates of its longer-run normal level.

The improvement in employment conditions this year has occurred amid continued expansion in economic activity. U.S. real gross domestic product is estimated to have increased at an average pace of 2¼ percent over the first three quarters of the year.

Inflation

Overall consumer price inflation— as measured by the price index for personal consumption expenditures—was only ¼ percent over the 12 months ending in October.

However, much of the shortfall from our 2 percent objective reflected the sharp declines in energy prices since the middle of last year, and the effects of these declines should dissipate over time.

The appreciation of the dollar has also weighed on inflation by holding down import prices. As these transitory influences fade and as the labor market strengthens further, the Committee expects inflation to rise to 2 percent over the medium term.

Rationale for Raising Interest Rates

With inflation currently still low, why is the Committee raising the federal funds rate target?

Much of the recent softness in inflation is due to transitory factors that we expect to abate over time, and diminishing slack in labor and product markets should put upward pressure on inflation as well.

In addition, we recognize that it takes time for monetary policy actions to affect future economic outcomes. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly at some point to keep the economy from overheating and inflation from significantly overshooting our objective. Such an abrupt tightening could increase the risk of pushing the economy into recession.

Fed Funds Forecast

The median projection for the federal funds rate rises gradually to nearly 1½ percent in late 2016 and 2½ percent in late 2017.

As the factors restraining economic growth continue to fade over time, the median rate rises to 3¼ percent by the end of 2018, close to its longer-run normal level.

The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Although developments abroad still pose risks to U.S. economic growth, these risks appear to have lessened since last summer. Overall, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced.

So on December 16^th, 2015, the FOMC itself projected they would raise the target rate 4 times in 2016, or approximately at every other meeting (presumably at the “live” meetings). Instead they raised interest rates once - a year later at the December 2016 meeting. What the hell happened?

FOMC Meeting of March 16, 2016 – the FOMC immediately gets cold feet, and pauses the rate hikes.

Excerpts from Chair Yellen’s remarks at the press conference (edited for brevity, formatting and subheadings added for clarity):

            Overview

Today the Federal Open Market Committee decided to maintain the target range for the federal funds rate at ¼ to ½ percent. Our decision to keep this accommodative policy stance reflects both our assessment of the economic outlook and the risks associated with that outlook. The Committee’s baseline expectations for economic activity, the labor market, and inflation have not changed much since December: With appropriate monetary policy, we continue to expect moderate economic growth, further labor market improvement, and a return of inflation to our 2 percent objective in two to three years. However, global economic and financial developments continue to pose risks. Against this backdrop, the Committee judged it prudent to maintain the current policy stance at today’s meeting.

Unemployment

The labor market continues to strengthen. Over the most recent three months, job gains averaged nearly 230,000 per month, similar to the pace experienced over the past year.

The unemployment rate was 4.9 percent in the first two months of the year, about in line with the median of FOMC participants’ estimates of its longer-run normal level.

A broader measure of unemployment that includes individuals who want and are available to work but have not actively searched recently and people who are working part time but would rather work full time has continued to improve.

Of note, the labor force participation rate has turned up noticeably since the fall, with more people working or actively looking for work as the prospects for finding jobs have improved.

But there is still room for improvement: Involuntary part-time employment remains somewhat elevated, and wage growth has yet to show a sustained pickup.

Inflation

Overall consumer price inflation—as measured by the price index for personal consumption expenditures—stepped up to 1¼ percent over the 12 months ending in January, as the sharp decline in energy prices around the end of 2014 dropped out of the year-over-year figures.

Core inflation, which excludes energy and food prices, has also picked up, although it remains to be seen if this firming will be sustained. In particular, the earlier declines in energy prices and appreciation of the dollar could well continue to weigh on overall consumer prices.

But once these transitory influences fade and as the labor market strengthens further, the Committee expects inflation to rise to 2 percent over the next two to three years.

Economic Outlook

The median growth projection edges down from 2.2 percent this year to 2 percent in 2018, in line with its estimated longer-run rate.

The median projection for the unemployment rate falls from 4.7 at the end of this year to 4.5 percent at the end of 2018, somewhat below the median assessment of the longer-run normal unemployment rate.

The median inflation projection rises from 1.2 percent this year to 1.9 percent next year and 2 percent in 2018.

Rationale for Not Raising Interest Rates

Since the turn of the year, concerns about global economic prospects have led to increased financial market volatility and somewhat tighter financial conditions in the United States, although financial conditions have improved notably more recently.

Economic growth abroad appears to be running at a somewhat softer pace than previously expected.

These unanticipated developments, however, have not resulted in material changes to the Committee’s baseline outlook (because):

·       Market expectations for the path of policy interest rates have moved down, and

·       The accompanying decline in longer-term interest rates should help cushion any possible adverse effects on domestic economic activity.

Indeed, while stock prices have fallen slightly since the December meeting and spreads of investment-grade corporate bond yields over those on comparable-maturity Treasury securities have risen, mortgage rates and corporate borrowing costs have moved lower.

The Committee will continue to monitor these developments closely and will adjust the stance of monetary policy as needed to foster our goals of maximum employment and 2 percent inflation.

Fed Funds Forecast

Compared with the projections made in December (editor: only 3 months ago) the median path is about ½ percentage point lower this year and next; the median longer-run normal federal funds rate has been revised down as well.

Most Committee participants now expect that achieving economic outcomes similar to those anticipated in December will likely require a somewhat lower path for policy interest rates than foreseen at that time.

Followed by two paragraphs of why the FOMC member’s projections for the fed funds rate are individual forecasts, but not “plans” for future policy, because the future is uncertain and unexpected things happen and don’t ever hold us to a decision or an outlook. God forbid anyone need to make investment decisions or recommend a trading strategy based upon future interest rates.

First question out of the gate (from my hero, Steve Liesman):

Madam Chair, as you know, inflation has gone up the last two months. We had another strong jobs report, the tracking forecasts for GDP have returned to 2 percent, and yet the Fed stands pat while it’s in a process of what it said it launched in December was a “process of normalization.” So I have two questions about this:

1.     Does the Fed have a credibility problem, in the sense that it says it will do one thing under certain conditions but doesn’t end up doing it?

2.     And then, frankly, if the current conditions are not sufficient for the Fed to raise rates, well, what would those conditions ever look like?

I will spare you Chair Yellen’s answer, but it boils down to the following:

·        The “median forecast” for the appropriate path of monetary policy is meaningless, because the FOMC is ruled by the doves, and I am their queen.

·        Global growth outside the United States is slowing and there has been some widening of credit spreads (the spread between US Treasuries and investment grade or high yield bonds). Despite the fact that these events have at best tertiary impact on our mandate, we are still collating.

·        So when we said we were going to gradually raise rates, we meant at the pace of a tortoise, because we prefer to make no decision at all than to make a decision which might, you know, have consequences.

FOMC Meeting of June 15^th, 2016 - wherein the FOMC enters the Twilight Zone.

I can’t with this meeting. Here’s the synopsis:

·        The economic data was mixed. It vexes us.

·        GDP growth in late 2015 / early 2016 was “lackluster,” though they expected it to improve.

·        Job market gains averaged 200k per month - though April and May were weaker at 80k per month - and the unemployment rate fell to 4.7% in May.

·        Yellen (roughly paraphrased): “yabbut, that’s because more people dropped out of the labor force (they’re called boomer retirees, Janet), and besides, there are still too many people working part-time who want full-time jobs.” Editor’s note: Not Your Problem.

·        The year-end median forecast for the unemployment rate – which has been revised lower to 4.6% - is now below the FOMC’s assessment of the longer-run normal unemployment rate.

·        Average hourly earnings increased 2.5% over the prior 12 months, a “welcome indication that wage growth may finally be picking up.” Grammar and thought police: Wage growth, in fact, picked up. For a whole year. Remember, it’s historical data.

·        Inflation rose to 1% for the 12 months ending in April. Core inflation (ex food and energy) was running closer to 1.5% over the same period. Both moving higher towards the stated target.

            Rationale for Still Not Raising Interest Rates

This decision (not to raise interest rates) reflects the Committee’s careful approach in setting monetary policy, particularly in light of the mixed readings on the labor market and economic growth that I have discussed, as well as continuing below-target inflation.

Although the financial market stresses that emanated from abroad at the start of this year have eased, vulnerabilities in the global economy remain.

In the current environment of sluggish global growth, low inflation, and already very accommodative monetary policy in many advanced economies, investor perceptions of, and appetite for, risk can change abruptly.

We continue to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate. We expect the rate to remain below levels that are anticipated to prevail in the longer run because headwinds weighing on the economy mean that the interest rate needed to keep the economy operating near its potential is low by historical standards. These headwinds—which include developments abroad, subdued household formation, and meager productivity growth—could persist for some time.

Editor’s note: The “vulnerabilities in the global economy” and “developments abroad” that Yellen is alluding to is a feared reaction to the UK’s Brexit vote, which is mere days out from this meeting (it took place on June 23^rd, 2016). She is asked about it during the Q&A, but we don’t rehash it since:

a)     It has so far not turned out to be some huge global disaster; and

b)     Even the most bearish economists did not expect it to – nor has it had - a big impact on the US economy.

On a closing note, the FOMC reports that its (completely meaningless and laughably wrong) median forecast / projection for the fed funds rate for year-end 2017 is now 1.50%, rising to 2.50% for year-end 2018.

FOMC Meeting of September 21, 2016 – the one where the FOMC actually said “instead of raising rates we lowered our forecast.”

In a nutshell:

o   Economic growth had substantially improved. The drivers were higher household spending, based on solid increases in household incomes, consumer sentiment and wealth.

o   Job gains rebounded to average ~180k per month over the preceding 4 months, and the unemployment rate was stable at 4.9%.

o   Inflation was just below 1%, with the shortfall again attributed to the transitory factors of low energy and import prices. Core inflation was 1.5%.

  

In fact, the economy was doing so well, that the focus of the Yellen’s remarks revolved around a laborious attempt to justify not raising rates.

The “Neutral Fed Funds Rate” Gets a Promotion

The recent pickup in economic growth and continued progress in the labor market have strengthened the case for an increase in the federal funds rate. Moreover, the Committee judges the risks to the outlook to be roughly balanced. So why didn’t we raise the federal funds rate at today’s meeting? Our decision does not reflect a lack of confidence in the economy.

(blah blah nothing to see here blah)

We continue to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate over time to achieve and maintain our objectives. That’s based on our view that the neutral nominal federal funds rate—that is, the interest rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel—is currently quite low by historical standards. With the federal funds rate modestly below the neutral rate, the current stance of monetary policy should be viewed as modestly accommodative, which is appropriate to foster further progress toward our objectives. But since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future, and gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance over the next few years.

So this economic construct – this fictitious rate that the FOMC made up – moves around based on their projections for some future state of the economy. Now instead of raising interest rates congruent with: their monetary policy objectives, and the plan outlined nine months prior (and almost immediately abandoned), the FOMC claims that the target fed funds rate at a whopping 0.50% is now only “modestly accommodative” because it’s long term neutral level is lower than previously guesstimated. Three months prior in June the FOMC characterized the same fed funds rate as "very accommodative". 

Can someone design an index out of this rate? I know some former Libor traders who would love to make a market in it.

First ball, fast ball hitter Steve Liesman:

Madam Chair, critics of the Federal Reserve have said that you look for any excuse not to hike, that the goalposts constantly move. And it looks, indeed, like there are new goalposts now when you say looking for “further evidence” and—and you suggest that it’s evidence that labor—labor market slack is “being taken up.” Could you explain what “for the time being” means, in terms of a time frame, and what that further evidence you would look for in order to hike interest rates? And also, this notion that the goalposts seem to move, and that you’ve indeed introduced a new goalpost with this statement.

I think you had to be there to truly appreciate the obfuscation in her answer. If you’re interested, it is in the transcript (starting on page 5 of 24).

Tuesday, November 8, 2016 - Donald Trump wins the presidential election and Republicans take a majority of seats in both chambers of Congress.

Over time: Legislation dating back to 2008 to “audit the Fed” is revived. Pressure on Yellen to resign as Fed Chair increases. Yellen states publicly and candidly that she intends to complete her term as Chair, which ends in January of 2018. Fed Governor Daniel Tarullo – architect of an enormous amount of banking and financial markets regulation phased in following the financial crisis – announces his resignation, effective April 2017. Trump and the Republicans begin planning legislation to scale back parts of Dodd-Frank, to repeal or reconstruct pieces of Obamacare, to implement fiscal stimulus, to revamp and simplify tax policy. The equity markets tear higher.

FOMC Meeting of December 14^th, 2016 – the FOMC raises the target fed funds rate and nudges their economic projections higher.

The economic growth picture and employment data was roughly in-line with where it had been in September, though the unemployment rate hit a post-crisis low of 4.6% in November, the lowest level since 2007. Inflation ticked higher to 1.5%, as expected due to the rebound in energy prices. Core inflation rose to 1.75%.

The more meaningful change was the shift in tone in Yellen’s prepared remarks for the press conference. Gone were several of the dovish explanations for why the FOMC was effectively discounting good data by emphasizing lingering areas of weakness.

Some excerpts:

Today the Federal Open Market Committee decided to raise the target range for the federal funds rate by ¼ percentage point, bringing it to ½ to ¾ percent. In doing so, my colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability. Over the past year, 2¼ million net new jobs have been created, unemployment has fallen further, and inflation has moved closer to our longer-run goal of 2 percent. We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years.

Job gains averaged nearly 180,000 per month over the past three months, maintaining the solid pace that we’ve seen since the beginning of the year. Over the past seven years, since the depths of the Great Recession, more than 15 million jobs have been added to the U.S. economy. The unemployment rate fell to 4.6 percent in November, the lowest level since 2007, prior to the recession. Broader measures of labor market slack have also moved lower, and participation in the labor force has been little changed, on net, for about two years now, a further sign of improved conditions in the labor market given the underlying downward trend in participation stemming largely from the aging of the U.S. population.

Recall the transcript for the June 2016 meeting, where the drop in the unemployment rate in April to 4.7% was written off by the FOMC because it was driven by a drop in labor force participation, in favor of focusing on a measure of labor market slack – the number of part-time workers who want full-time jobs. These two metrics, which were worrisome enough in June and September to contribute to the FOMC deciding not to raise rates, are suddenly improving if understood in the context of a long-term trend. No kidding.

The more disturbing theme is that the FOMC press conference remarks seem to have taken on the tone of a campaign speech. It could be a campaign for Yellen to keep her job, for the Federal Reserve to avoid additional scrutiny of their regulatory and policy decisions, or a long overdue recognition that eight years post-crisis the economy has recovered and it may continue to improve if the FOMC gets its fanny off the yield curve.

FOMC Meeting of Tuesday, March 15^th, 2017 – if you don’t believe the Fed is going to raise rates and come out sounding like a bunch of hawks, you clearly haven’t been paying attention.

If you’re still reading, I applaud you. I am genuinely, deeply grateful.