E112 - How Interest Rates Actually Work: Fed Funds, Repo, and Treasury Auctions

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Don't forget to hit LIKE and SUBSCRIBEThe Fed cut rates and your mortgage went up. If that never made sense to you, this episode is the explanation. In part one of a two-part solo breakdown, Hans starts with the three interest rate stories dominating the macro headlines right now, the stubborn 10-year Treasury, Kevin Warsh's campaign to kill forward guidance, and Japan quietly letting its Treasury holdings roll off, and uses them as the entry point to a much bigger question: who actually sets the price of money?

Chapters

00:00 – Opening Segment

01:00 – Setting up the interest rate primer

02:25 – Headline one: the 10-year Treasury refuses to fall

03:55 – Why a weak jobs report makes the stock market celebrate

06:40 – Headline two: Kevin Warsh is killing forward guidance

09:00 – Shorter statements, no dot plot, and a market that has to do its own homework

13:35 – Headline three: Japan stops rolling its Treasury holdings

16:10 – The food chain: it was never one dial

20:25 – The fed funds rate is banks lending each other reserves overnight

25:25 – The dual mandate, CPI versus PCE, and how inflation gets measured

29:35 – Reserve requirements are now zero

32:15 – IORB: the floor the Fed actually sets

37:55 – The reverse repo facility and the discount rate ceiling

39:20 – The repo market: a pawn shop moving trillions a night

42:45 – LIBOR, the 2012 scandal, and the move to SOFR

44:10 – Primary dealers and the price of the golden ticket

47:00 – What QE really is and why the Fed can't buy direct from Treasury

52:00 – Inside a Treasury auction: bids, clearing yield, and the tail

57:05 – Recap and what's coming in part two

Key Takeaways

There is no such thing as "the" interest rate. There is a stack of them, and the Fed only has real influence over the short end. Everything between the Fed and your mortgage is a chain of institutions taking the rate handed to them, adding yield, and passing it down. The fed funds rate is not a number anybody types into a computer. It is a real market rate set between banks settling reserves overnight, and the Fed steers it with incentives rather than force. Forward guidance has been the Fed's most powerful tool, and it costs nothing to use. Saying the conditions might align for a cut can move markets as effectively as an actual cut, which is why Warsh trimming statements and abandoning the dot plot amounts to a real policy shift. The repo market, not the fed funds market, is where the money actually is. Fed funds is a small, uncollateralized club of primary dealers. Quantitative easing is the one situation where "printing money out of thin air" is literally accurate. The Fed is barred from buying new issues directly from Treasury, so the twenty-four primary dealers absorb whatever the auction does not clear and the Fed buys from them with newly created reserves. Treasury auctions price on demand, not decree. Treasury announces the quantity, buyers submit the yields they will accept, bids fill from lowest to highest, and the yield on the last dollar sold becomes the yield everybody gets.