Nuts and bolts of Fed liftoff

On Wednesday the Federal Reserve is likely to raise interest rates for the first time in nearly a decade. The Fed faces a unique challenge in tightening monetary policy with a $4.5tn balance sheet and nearly $2.5tn in excess reserves. To address this, the Fed has introduced a variety of new tools and adjusted its operating framework since the last time it raised rates. These tools include the interest rate on excess reserves (IOER), the overnight reverse repo facility (ON RRP), and their term equivalents. 

Overall, the Fed's tools should provide it with adequate ability to control short-term interest rates. The fed funds effective and Treasury general collateral repo rates are expected to trade in the lower half of the IOER to ON RRP range. Short-dated bills and agency discount notes will likely trade near or below the ON RRP rate while three-month LIBOR will likely settle at or slightly above the IOER rate. 

Year-end money market dynamics may cause the effective to trade very low or below the target range, but the Fed is expected to view this as a temporary phenomenon and not as a loss of interest rate control. If the Fed finds that it can't control money markets with the tools above, it may consider widening the IOER-ON RRP band or engaging in short-term asset sales.