The future of whether raising interest rates by the Fed will work hangs in the balance through the repo and not the Fed funds market. If the Fed can control reverse repo, it will be able to impact the key credit channel away from banks. The shadow credit markets are where the action is for lending and that is more likely to be driven by rates outside of banks.
The Fed knows this and has focused on new tools to monitor the repo market. See the new tool for monitoring by the NY Fed. The NY Fed is now able to watch volume, haircuts, and concentration levels for tri-party repo and show current levels versus historical data. The volume numbers are interesting, but what has really caught my attention are the haircuts for different types of collateral. Changes in haircuts will provide an early warning on the risks for certain types of assets. I would be concerned if the haircuts start to increase because it is telling the market that there are more risks in markets. If there is going to be a market gridlock, it will start with the haircuts in repo.
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