MNI INTERVIEW: Fed Leery of Money Fund Rescue, Reinhart Says

The Federal Reserve is likely to abstain from raising rates paid on reverse repos or excess reserves despite potential financial stability risks as money-market funds drown in surfeit liquidity, former Fed Board division of monetary affairs chief Vincent Reinhart told MNI.

"If there's a problem in bill rates because of the lack of issuance by the under secretary of the Treasury, pay downs, and running off the Treasury General Account, then take it up with Treasury," he said.

The Fed will focus on the fed funds rate which has remained relatively stable, and ignore softness in bill and repo rates, which are the Treasury's responsibility, Reinhart said in an interview.

Chair Jay Powell, who was Treasury under secretary for domestic finance in the George H.W. Bush administration, and who as Fed governor argued against Treasury and Fed cooperation on debt management, has made clear that the central bank should stick to its knitting, Reinhart said.

Moreover, there are political pressures at play that will prevent the Fed from taking action. "The Fed's got to be sensitive to that stuff," he said.

RAISING DEBT COSTS?

"Part of it is do you want to be Chair Jay Powell and go up to Capitol Hill and get asked the question of whether you actually really raised the cost of federal debt for the sake of short-term asset holders when unemployment is high and there's still over seven million people who are without jobs relative to pre-pandemic?" said Reinhart.

Short-term rates are down due to a decline in Treasury bill issuance, a rapid drawdown in the government's cash balance, and because markets are swimming in nearly USD4 trillion of reserves, in part because of the Fed's monthly bond purchases. Fed Vice Chair for Supervision Randal Quarles said recently he sees reserves reaching USD5 trillion by the end of the year.

But the central bank has adjusted its overnight reverse repo program that mops up reserves by expanding per-counterparty limits and loosening eligibility criteria for counterparties, now up to 123. Even with an interest rate of 0%, the facility has seen usage skyrocket, seeing a fresh record USD486 billion in cash sent its way on Monday.

Still, money market funds have complained that profitability and the economics of the industry have broken down, with some funds talking about the potential of limiting investor subscriptions or outright closing to new money.

BOUNCING ALONG LOWER BOUND

The Fed could offer money funds more relief by raising the rate it pays on those reverse repo operations or the rate paid on reserves. The Fed will be replacing IOER with a new unified rate, the interest rate on reserve balances (IORB), which will come into force on July 29.

But Reinhart added that supporting money-market funds not long after bailing out the industry for the second time in a dozen years and as regulators work to address those longer-term financial stability concerns adds further doubt to the prospect of a Fed rescue.

"If you think there's regulation necessary, do you want to adjust your monetary policy rates to otherwise offset those stresses?" Reinhart said.

Still, some outside analysts see a little over 50-50 chance the Fed could make a pre-emptive move on its administered rates as soon as the June FOMC meeting. Current and former officials told MNI they see the fed funds rate largely holding steady.

While Fed officials have said they could adjust rates if there is "undue" downward pressure, Reinhart said that could be a higher threshold.

The Fed would only raise IOER if the Fed "felt that the federal funds rate was trading in a way that casts doubt about their ability to control it," he said. "In other words, if it bounced along the effective lower bound."