Fed Tinkers With Tools to Defend Floor From Market Awash in Cash

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The Federal Reserve on Wednesday tweaked the rates on some of the tools used to help control the benchmark even as it left unchanged the overall target range for the fed funds rate.

The upward shift to the so-called administered rates comes amid the growing dollar glut in short-term funding markets that’s outstripping the supply of investable securities and weighing down front-end rates, despite the steadiness of the Fed’s key benchmark at 0.06%. Fed officials decided to raise the rate on its overnight reverse repurchase-agreement facility by 5 basis points to 0.05%, effective June 17. Policy makers also boosted the interest paid on excess reserves by 5 basis points to 0.15%, but left the main monetary policy goal unchanged at 0% to 0.25%.

At present, there’s $521 billion in cash squirreled away at the overnight RRP facility. Usage could increase as the amount of cash in the system continues to balloon, with Fed asset purchases, fiscal stimulus payments and a debt-ceiling related drawdown of the Treasury main account all contributing to the situation.

Federal Reserve Chair Jerome Powell said during the post-meeting press conference that policy makers think the facility is “doing what we think it’s supposed to do.”

Central bank officials also signaled that the pace of the U.S. economic recovery from the pandemic is bringing forward their expectations for how quickly they will reduce policy support.

Key Insights

  • “This technical adjustment was done to move the floor under market rates – shifting it higher to reduce the possibility of negative interest rates,” said Barclays Plc strategist Joseph Abate, who noted that repo and bill rates have been pinned at 0% since April.
  • Ahead of the decision, strategists were split as to whether or not policy makers would make such a tweak. Those in the “no change” camp, such as Credit Suisse and Citigroup, noted that the fed funds rate has been steady and the efficacy of the RRP as a floor for short-term rates.
  • However, Bank of America and JPMorgan argued that there were financial stability reasons for the Fed to tinker with rates, highlighting the importance of money-market funds in transmitting monetary policy.
  • Strategists have said that if money funds start to turn away cash, it could find its way directly into short-end instruments, pushing yields on Treasury bills and overnight repo below zero and potentially weakening the efficacy of the RRP facility as a floor.
  • In the minutes of the previous Federal Open Market Committee gathering, the Fed’s System Open Market Account manager, Lorie Logan, noted that downward pressure on overnight rates in coming months could result in conditions that warrant consideration of a modest adjustment to administered rates. Logan noted that more than half of survey respondents expected an adjustment to administered rates by the end of the June policy meeting.
  • The last time officials tinkered with administered rates relative to their overall target range was January 2020, before the pandemic shock. Back, then the Fed opted to increase both the IOER and RRP rates by 5 basis points apiece after fed funds slipped to be just 4 basis points above the lower bound of 1.5%.
  • Before that, the only comparable tweaks it had made to IOER and RRP levels were actually in the other direction to help keep a cap on fed funds.

Market Action

  • Treasury bills yields across the curve rose after the central bank announced tweaks to the administered rates.
  • Treasuries dropped sharply to session lows with 10-year yields jumping back above 1.50% after Fed’s latest economic projections show two rate increases by the end of 2023.
  • Eurodollar futures show the first full Fed rate hike priced in by the end of 2022

Get More

  • A link to the minutes from the April meeting of the Federal Open Market Committee
  • A story on whether the Fed will tweak its monetary policy toolkit and help out money markets that are starting to drown in a sea of cash
  • Story on Wednesday’s monetary policy decision by the Federal Reserve

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