Fears of Fed’s Main Rate Dropping Too Low Starts to Lift
(Bloomberg) -- The rate that the Federal Reserve targets to control monetary policy is defying the skeptics by holding firmly above zero, prompting a rethink from those who thought the central bank might need to step in and tinker with the front end.
While rates on repurchase agreements and other short-term markets have gone negative at times amid the current influx of dollars from the shrinkage of the huge U.S. Treasury cash pile, the effective fed funds rate has held steady at 0.07% since Feb. 18. That’s toward the lower end of the Fed’s target range of 0 to 0.25%, but without a further decline observers are now doubtful that the Fed will act.
Strategists from Barclays Plc, Wrightson ICAP and Bank of America Corp. had all previously anticipated that officials might need to make upward adjustments as soon as this month’s Federal Open Market Committee meeting to two key rates it sets -- those for its overnight reverse repurchase agreement facility and for interest on excess reserves. They’ve now become more circumspect.
“The argument in favor of a tweak is not as strong as we thought it would be by now,” Wrightson ICAP economist Lou Crandall wrote in a note to clients Monday, citing the stickiness of the fed funds rate. He also said that “any rate hike at all – even of just a few basis points – would create communications challenges outside the money markets.”
The steadiness in the front end comes at a time when pressure is mounting for policy makers to address potential issues with long-end yields. The benchmark 10-year yield climbed as high as 1.62% Friday -- the highest since February 2020 -- before dip buying from foreign investors emerged.
Barclays strategist Joseph Abate dropped his call for an increase in short-term rates at next week’s Fed meeting, noting the path of the fed funds rate is complicated by a slower-than-anticipated decline in the balance of the Treasury’s bank account at the central bank. While the $1.37 trillion cash pile is down from $1.66 trillion at the beginning of February, it’s still some ways from the Treasury’s end-March forecast of $800 billion.
Though, there’s a chance that the steadiness of the fed funds rate is only temporary.
“Now that the Biden administration’s aid package is set to pass Congress, the Treasury’s cash balance could fall faster, releasing bank reserves more quickly,” Abate said. As a result, the strategist isn’t completely ruling out the possibility that the Fed revisits lifting the administered rates at the April FOMC meeting, although fed funds futures are not priced for such an action.
Even Bank of America strategist Mark Cabana isn’t completely ruling out an upward adjustment at the March 16-17 FOMC meeting, though it may take a significant market move to push the fed funds rate to 5 basis points, a level that could trigger an adjustment.
“If fed funds remains stickier for longer, we expect the Fed will not adjust IOER and be more reactive than proactive to money market developments,” Cabana and strategist Olivia Lima wrote.
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