U.S. Funding Rates Keep on Rising, Fueling Talk of a Fed Tweak

(Bloomberg) -- The benchmark targeted by the Federal Reserve is on the rise again and that’s leading some to question whether the central bank could make adjustments as soon as this week to maintain control of the rate.

The effective fed funds rate rose to 2.45 percent on Monday, according to central bank data released Tuesday. That’s well above the central bank’s interest on excess reserves rate -- a level that’s historically acted as a cap for the benchmark and currently stands at 2.40 percent -- fueling questions about a possible tweak to IOER by officials. While fed funds is still within the central bank’s overall target range of 2.25 percent to 2.50 percent, it is creeping higher within that band.

The most recent rise in the rate “has to meaningfully increase the odds” of a change to IOER when the Fed delivers its scheduled policy decision Wednesday, NatWest Markets strategist Blake Gwinn said by email. Even though the Fed has been comfortable on previous occasions with the benchmark rate being five basis points below the top of the band, “the trajectory this time around is a bit more alarming,” he wrote.

The fed funds rate has been firmly above IOER for more than a month and has climbed four basis points in less than two weeks. Some observers have seen the rise in fed funds more as a product of recent distortions within the market for repurchase agreements and the effects of America’s tax season. The Treasury’s collection of tax receipts has pushed the government’s cash balance higher, which typically reduces the level of bank reserves. Combined with flows out of money-market funds -- which may also be in part related to the payment of individuals’ and companies’ tax bills -- that means there is less private money to put to work in the repo market.

That in turn has driven up repo rates, and also appears to have spilled over into fed funds because it can draw some lenders away from the unsecured market and into the more attractive rates offered by repo.

The rate on overnight general collateral repurchase agreements soared on the final trading day of April, climbing to levels unseen since the end of the first quarter. The rate reached around 2.88 percent in early New York trading hours, up from roughly 2.57 percent on Monday, ICAP data show. It subsequently pared its rise to 2.84 percent.

Repo rates typically move higher at the end of the month as some dealers curtail activity in the financing markets to shore up their balance sheets. Adding to the upward pressure is a potential influx of additional collateral, with settlements on Tuesday for around $235 billion in new Treasury bills and coupon-bearing securities. On top of that, those recent outflows from government money-market funds means there’s been less cash to lend in the repo market, which could also be contributing to elevated rates.

The increase in the repurchase agreement rate is also likely to have a knock-on effect for the Secured Overnight Financing Rate, the repo-linked heir presumptive to the London interbank offered rate.

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Elizabeth Stanton

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