MNI: Fed IOER Hike On Hold Unless Debt Limit Talks Drag On

Possible hikes in the Federal Reserve's rates on overnight reverse repos and excess bank reserves look to have been parked for now, with officials only likely to move if negotiations over the U.S. debt limit drag on into the fall, current and former officials told MNI.

A shift in the Treasury's financing plans earlier this month will likely result in its releasing fewer reserves into the banking system. That combined with a recently-upsized overnight reverse repo facility is alleviating downward pressure on the benchmark fed funds rate and paring back expectations for an IOER and ON RRP hike in the near term.

"The fact that the Treasury is not going to be holding [reserves] down even more means it's got to help at the margin and help prop rates up a little bit," said Todd Keister, a former New York Fed economist currently a visiting scholar at the Philadelphia Fed.

However, the longer the debt ceiling talks drag on, the more Treasury's cash balance would fall, renewing pressure on the fed funds rate. Treasury said May 3 it will target a July 31 cash balance of USD450 billion, more than USD300 billion higher than previous estimates, and slow its T-bills paydowns by USD150 billion.

DEBT CEILING UNCERTAINTY

Lawmakers are sharply divided on the debt limit, with Republicans writing into caucus rules they will not support raising the ceiling without spending cuts. While Secretary Janet Yellen has said the Treasury's "extraordinary measures" to make payments on previous debts could run out in the early summer in some scenarios, some analysts say Treasury's cash balance could provide a cushion into October.

If the squabble goes on long enough, the Treasury could need to ramp up bill issuance more rapidly after the debt limit is dealt with, which could lift short-term rates again, sources said. Fed research shows an additional trillion dollars of Treasuries with less than a year to maturity tends to increase fed funds by about 3bps, MNI previously reported.

"At some point the downward pressure would become upward pressure, but that is hard to know precisely and hard to establish," Antoine Martin of the New York Fed told MNI.

Some outside analysts warn of a small chance the Fed could surprise with a pre-emptive move on its administered rates as soon as the June meeting. But sources told MNI the Fed prefers to be patient.

Even as money market rates have dipped into negative territory, with some T-bill rates this week at 0%, the New York Fed has signaled there's little reason to increase administered rates without additional "undue downward pressure" on the benchmark fed funds rate. The NY Fed's markets chief Lorie Logan has said that some negative rates, particularly the SOFR first percentile, appear "technical in nature."

RELIEF VALVE

"We are now in a situation where it's kind of convenient for the Fed to keep targeting the fed funds rates because that rate seems to be more stable and doesn't move much whenever the repo rates go down," said Quentin Vandeweyer, who worked in the Research Directorate of the European Central Bank and is an outside Fed adviser.

He added he expects short-term rates to remain "more or less stable around where they are right now, especially because of the reverse repo facility that's in place and that's absorbing some of the movements in rates."

The central bank appears to be satisfied with increased usage of the reverse repo facility after per-counterparty caps were lifted in mid-March to USD80 billion from USD30 billion. Usage has rocketed to over USD350 billion in the past two months, and some ex-officials expect that could temporarily spike to USD1 trillion at quarter-end next month, well above the previous all-time high of roughly USD650 billion.

"The Fed appears much more comfortable with the reverse repo facility than it did in 2013 and 2014 when it was started," said Keister, the Philly Fed visiting scholar. "Maybe it could get much bigger going forward and the most likely outcome would be that would be just fine."