Cracks Are Emerging in the Fed’s Floor as Key Target Rate Slides
(Bloomberg) -- The key benchmark that the Federal Reserve targets to control monetary policy dropped for the second time in two weeks, an indication that the glut of cash in the front-end is starting to spill into this corner of the funding markets.
The effective fed funds rate, which the central bank is currently aiming to keep within a range of 0% to 0.25%, slipped by 1 basis point to 0.08% on Aug. 27, the Fed said Monday. That’s closed the gap to the offering yield on the Fed’s overnight reverse repurchase agreement facility, which is supposed to act like a floor for the front end, to just 3 basis points. It could narrow further amid supply-demand imbalances and month-end effects with banks pulling back from funding markets to beef up balance sheets.
The pressure pushing down overnight rates toward zero is proving a major headache for money-market funds. It hampers their ability to invest profitably, and can lead to further disruptions as they begin to waive fees to avoid passing on negative rates to shareholders. A number of firms including Vanguard Group shut down prime money-market funds last year after struggling to cover operating costs in the low-interest-rate environment.
Money-market rates have been under pressure all year as a result of the central bank’s long-standing asset purchases and drawdowns of the Treasury’s cash account, which is pushing reserves into the system.
At the same time, supply has been dwindling, especially as the Treasury cuts bill supply to create more borrowing room under the debt ceiling, leaving investors scrambling for places to park cash. Those that have access to the Fed’s so-called RRP facility have opted to leave money there, pushing balances to all-time highs in recent days.
“The system certainly remains very flush with liquidity,” said Credit Suisse strategist Jonathan Cohn. “That said, the capacious RRP facility, as well as apparent Fed willingness to lift counterparty limits should they result in downward pressure on overnight rates, definitely reduces the risk associated with such a backdrop.”
The Fed at its June meeting had raised its administered rates by 5 basis points to help support the smooth functioning of short-term funding markets. Lorie Logan, manager of the System Open Market Account at the New York Fed, noted in the minutes of the July 27-28 gathering that it may become appropriate to lift the RRP counterparty limit from $80 billion if a number of users reached their threshold.
Seventy-nine participants Monday tapped the facility for $1.141 trillion, the highest since the record of $1.147 trillion was reached on Aug. 25, New York Fed data show.
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