MNI EXCLUSIVE: Fed Signals Patience on IOER After Repo Move

The Federal Reserve will wait to hike the rates it pays on bank reserves and reverse repos after upsizing its overnight reverse repo facility per counterparty limit last week, former New York Fed officials and market sources told MNI.

The benchmark fed funds rate is holding steady at 7bps, well within the target range of 0% to 0.25%, and an increase in the per-institution limit on participation in overnight reverse repos is buying the Fed some time before it must raise its administered rates, sources said.

Flows into the ON RRP facility have risen by tens of billions per day from near-zero since last week's move, a modest increase but close to a one-year high. Sources said markets' willingness to use the facility could alleviate pressure on money market rates such as SOFR, which is trading at just 1bp, by siphoning reserves out of the system.

While an intermeeting move to hike IOER and ON RRP by a few basis points is "conceivable," the central bank will be "very patient," James McAndrews, former research director at the New York Fed, told MNI. "If the fed funds rate were soft for a few days or weeks, I don't think it's that significant of an issue, so I would expect the Fed to act deliberately and probably wait until an FOMC meeting."

MNI previously reported that Fed could increase both the ON RRP and IOER rate by 3 to 5 bps if the fed funds rate fell a couple bps below its current level.

MONEY MARKET DISRUPTION

A flood of cash reserves from QE and the Treasury as well as money fund inflows have sent money market rates sharply lower this year, with the first and 25th percentiles of SOFR transactions hitting record lows of -5bps and 0bp, respectively, this week.

Some of the recent softness in repo rates may be traced to the mortgage GSE float period, when they invest more in the repo market, one source said. But short-term interest rates will see additional downward pressure -- from a drawdown of the Treasury cash balance to meet a summer debt limit deadline, additional Fed bond purchases and increased GSE lending in the interbank market, said Christopher Russo, a former staffer on the New York Fed's open market trading desk.

Negative money market rates have the potential to wreak havoc on all financial markets, but there are signs that the precautionary increase in the ON RRP facility's counterparty cap has helped, sources said. Since the move, rates in triparty repo, where U.S. dealers obtain a large part of their secured funding, have stayed above the ON RRP rate.

Raising the ON RRP cap "signals that the [New York Fed's trading] desk is paying close attention, and that they're standing ready and monitoring market events to ensure that repo and reverse repo are available as the market requires," said Russo.

RRP INFLOWS

The size of daily RRP auctions is likely to rise considerably in the weeks ahead, in part as globally systemically-important banks could park cash in money funds as they see additional constraints on reserves due to SLR relief ending as scheduled March 31, sources said. The Fed has signaled concern over the leverage ratios becoming a binding constraint on GSIBs but is comfortable with the size of the existing buffer while it mulls longer term adjustments on SLR.

"They're obviously trying to figure out a way to make it so that people can hold all those reserves," said Stephen Cecchetti, another former director of research at the New York Fed.

Upsizing the ON RRP facility will ensure capacity to handle inflows well above the previous all-time high of roughly USD650 billion, given that aggregate assets under money markets have increased and become more concentrated since the last increase in 2014 and that total bank reserves could jump by another USD1.5 trillion between now and August, sources said.

"If Treasury bill rates go below zero, then one could expect the ON RRP facility to receive significant inflows, and the Fed wants to accommodate those," said McAndrews. "As the balance sheet grows, all else equal, one might expect the size of the overnight reverse repo facility would grow as well."