Federal Reserve Poised to Make a Move on Cash
As the Federal Reserve enters a period of uncertainty, it’s likely to take a significant step on Wednesday to reduce the amount of cash on its balance sheet. Economists expect the Fed to announce a larger cut to the rate it pays money market funds and others to park cash at its overnight reverse repo facility (ONRRP) compared to the expected cut to its policy rate.
A Shift in Strategy
The Fed has adjusted the rate differential between fed funds and ONRRP previously, but this time, it’s seen as a move to gain flexibility as it sheds bond holdings, known as quantitative tightening (QT). By harmonizing the spread, the central bank can encourage people to find alternatives to parking money at the Fed, which will likely lower money market rates as well.
The Role of ONRRP
The reverse repo rate is designed to set a soft floor for short-term interest rates, along with the rate paid to deposit-taking banks for reserves. This helps keep the Fed’s policy rate within its targeted range. However, the ONRRP facility has become a provider of safe assets to the money fund industry, which was never the Fed’s intention.
A Temporary Solution Becomes Permanent
Active usage of the ONRRP facility was meant to be temporary, but it has lasted for a long time. The facility has contracted significantly since its peak of $2.6 trillion at the end of 2022, but it still remains range-bound and has yet to slide below $100 billion.
Challenges Ahead
Making it less attractive to park cash at the Fed may not be enough, as some money funds are large enough to have challenges placing cash elsewhere. Additionally, the Fed itself sees possible challenges to getting cash out of ONRRP and QT’s end, given the potential for a reintroduction of the government debt ceiling next year.
Uncertainty Lies Ahead
The weeks ahead will be unsettled for money markets, adding to the difficulty in predicting an end to QT. Quarter-end volatility has been rising, with broad expectations that ONRRP will see a year-end spike. While this may be just a bump in the road, it’s clear that the Fed’s move on Wednesday will have significant implications for the future of cash on its balance sheet.
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