NEW YORK (Reuters) – If the Federal Reserve really desires to move among the mountain of money now residing in its overnight reverse repo facility, technical changes in its rate control toolkit would do the trick, some central bank watchers say.
The tweaks they envision will not be shifts within the federal funds goal rate, the central bank’s primary tool for influencing the economy to realize its job and inflation goals. As an alternative, it comes right down to changing the setting of two other rates relative to the fed funds range in a way that departs from recent practice but could nudge money market funds to hunt one other home for among the $2 trillion a day now deposited on the Fed.
Those two rates exist to maintain the market-driven fed funds rate in the specified range. One, called the reverse repo rate, sets a floor underneath short-term rates, while one other, which pays deposit-taking banks to park money on the Fed, sets the high end.
The reverse repo facility takes in money from money market funds and other eligible firms, and currently pays an annualized rate of 4.30% for overnight loans of money, in comparison with the present federal funds rate range of between 4.25% and 4.5%.
The Fed is widely expected to lift the goal rate to 4.5% to 4.75% at Wednesday’s Federal Open Market Committee meeting. If it sticks to recent practice, it’ll raise the reverse repo and the interest on reserve balances rate, now at 4.4%, by the identical 25 basis point increment.
But some Fed watchers say the central bank has a alternative, one it could take this week or later. And if it does do a tweak now, it will be unlike past tweaks. Those adjustments happened purely to make sure control of the fed funds rate, while this kind of move would speak more directly to greater monetary policy concerns around managing the scale of its $8.5 trillion balance sheet.
The reverse repo facility has seen sustained inflows of over $2 trillion per day since last June and has didn’t contract as many policymakers expected. On many days, the ability offers the best overnight rate available to many firms, so it’s a no brainer for them to skip the private market and park money on the Fed.
“If [policymakers] wanted a small balance sheet, they might reduce the overnight [reverse repo rate]” relative to the federal funds rate “and that may drive money out of overnight [reverse repo,] drive it into reserves,” which might in turn give them extra space to chop the scale of their balance sheet, said William English, a finance professor on the Yale School of Management who’s formerly a top Federal Reserve staff member.
Given the strong likelihood of 1 / 4 percentage point increase Wednesday, Bill Nelson, who can also be a former top Fed staffer and now serves as chief economist with Bank Policy Institute, said the Fed could once more make the reverse repo rate match the underside end of the brand new federal funds rate range, with the interest on reserves rate matching the highest.
Doing this transformation now “would probably be easier to clarify and fewer newsworthy than making the change at another time or to another configuration,” Nelson said.
The Fed has tweaked the relative rate settings several times since adopting its so-called abundant-reserves approach after the financial crisis, and pursuing Nelson’s suggestion would mark the primary time since June 2018 that the interest on reserves and reverse repo rates were set to match the upper and lower bounds of the fed funds range.
Some out there fear rate control toolkit tweaks might create unneeded headaches if done too aggressively. Scott Skyrm, of cash market trading firm Curvature Securities, warned that ought to the Fed straight up hold the reverse repo rate at 4.3%, which could be unlikely, “it will create a severe dislocation in overnight rates…Imagine $2 trillion entering the repo market over a course of a couple of days.”
As an alternative, Skrym expects the Fed to bump the 2 rates up by the identical amount because the federal funds rate on Wednesday, in step with its recent practice.
(Reporting by Michael S. Derby; Editing by Dan Burns and Andrea Ricci)
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