IOER Hike Debate, Small Chance Pre-FOMC Move; Keep Eye On EFFR

The debate on whether the Fed will raise interest on excess reserves (IOER) has grown since repo rates collapsed to practically 0.0% late last wk (SOFR: 0.02%; BGCR: 0.01%; TGCR: 0.01%), while daily Effective Fed Funds Rate holds steady at 0.08%.

• Bank of America, Citigroup, Deutsche Bank and Wells Fargo are all anticipating a hike to IOER later this year while Bank of Montreal (BMO) suggests there is even a chance of an off schedule policy annc from the Fed if EFFR slips 5%. "There is ample room for the Committee to raise the administered rate within the target band and head off any worries on the lower bound's integrity in a reversal of the cuts that brought EFFR lower several times over the last cycle," BMO said.
• Counter argument From Credit Suisse contributor Zoltan Pozsar: despite the collapse in repo rates "and bill yields being possibly negative," with "robust volumes" in EFFR "between 8 and 4 bps, we don't think the Fed will raise IOR, nor do we think it should. IOR hikes won't fix what is a collateral problem." Zoltan cites 5 reasons the Fed won't hike IOER:
• 1) EFFR won't go negative. FHLBs can deposit cash at the Fed at zero, and unless the Fed cuts that rate below zero, FHLBs won't invest below zero.
• 2) FHLBs won't leave all their cash at zero at the Fed, given there will always be a foreign bank with the balance sheet to arbitrage the EFFR and IOR rates.
• 3) Foreign banks currently do this arbitrage for 2 bps – they don't need much.
• 4) FHLBs won't lend to foreign banks below 3 bps, as credit departments require at least 3 bps over the Fed's zero rate to cover foreign banks' credit risk.
• 5) Foreign banks currently contend with 2 bps, they won't push the EFFR down to 3 bps. The fed funds market is a relationship market. Balance matters.