Fed Takes Steps to Smooth US Funding Markets
The Federal Reserve has made a significant move to maintain stability in US funding markets, lowering the rate on its overnight reverse repurchase agreement (RRP) facility to 4.25%. This adjustment comes alongside a reduction in the overall target range for the fed funds rate to 4.25% to 4.50%.
Aiming for a Smooth Ride
By aligning the RRP rate with the lower bound of the target range, the Fed is working to prevent disruptions in the US financial system. The RRP facility provides an alternative investment option for money-market investors, helping to create a floor beneath overnight interest rates. Currently, financial institutions have approximately $132 billion in cash stored at the Fed’s overnight RRP facility, down from a peak of $2.55 trillion at the end of 2022.
Gauging Excess Liquidity
The balance at the RRP facility serves as an indicator of excess liquidity in the US financial system, influencing the Fed’s decisions on quantitative tightening. As the central bank continues to shrink its balance sheet, this move is expected to exert downward pressure on money market rates and impact the amount of funds held at the Fed facility.
A Foreshadowed Move
The Fed’s November meeting minutes hinted at a potential “technical adjustment” to equalize the RRP rate with the bottom of the target range for the federal funds rate. Market experts anticipate this move will lead to a decrease in money market rates and further impact the amount of funds held at the Fed facility.
Past Adjustments
In June 2021, the Fed raised the RRP rate to combat a dollar glut in short-term funding markets, which was weighing down front-end rates despite the stability of the Fed’s key benchmark. At the time, there was $521 billion in cash at the overnight RRP facility.
Expert Insights
Dallas Fed President Lorie Logan suggested in an October speech that reducing the RRP rate could be necessary if balances in the facility don’t decline as repo rates rise closer to the interest rate on reserve balances. Strategists predict the RRP reduction will lead to a decrease in the Secured Overnight Financing Rate and Tri-Party General Collateral Rate by at least 3 to 4 basis points.
Market Reaction
The move has sparked some buying of January SOFR-fed funds futures spreads, with the two-year Treasury yield touching 4.33% and the 10-year yield reaching 4.45%. As the Fed continues to navigate the complex landscape of US funding markets, market watchers will be closely monitoring the impact of this adjustment.
Leave a Reply