By Michael S. Derby
A once obscure Federal Reserve rate control facility is now holding nearly half a trillion dollars day after day, and the New York Fed's leader isn't concerned.
Over recent weeks, eligible financial firms, mainly money-market funds, banks and government sponsored entities, have been moving ever larger amounts of money into what the U.S. central bank calls its reverse repo facility.
On Monday, just days ahead of the next rate-setting Federal Open Market Committee meeting, cash parked on the Fed's books by these firms hit a record $486 billion. That marks the second time reverse repo activity notched a record in recent weeks, and compares with the last peak on the final day of 2015, when reverse repo volume reached $476 billion.
Many market participants have looked at the reverse repo activity with some unease. Financial firms have been willing to take the zero percent the Fed offers them through the facility in large part because there are few other short-term investments available, and in some cases, these private market investments actually cost money to invest in. That makes the Fed's zero percent repo rate attractive on a relative basis.
"The system is working exactly as designed," New York Fed President John Williams said in a video interview on Yahoo Finance last Thursday. The reverse repo facility, he added, is "working really well and the fact that funds are flowing between the banking system and our overnight reverse repos, this is kind of how we would expect that to happen" given the level of money coursing through short-term markets.
The reverse repo facility exists in large part to help the Fed control the federal-funds rate. It is designed to set the bottom end of what is now a 0% to 0.25% federal-funds rate range, with another rate, which the Fed calls the interest on excess reverse, or IOER, standing at 0.10%.
The growing use of the reverse repo facility follows Lorie Logan, who manages the Fed's massive $7.9 trillion holdings of cash and securities, having said recently that the central bank would rely on it more and expand the number of firms that could access it. The timing of that shift lined up with the wall of cash that started flowing to the Fed.
What is happening at the reverse repo facility doesn't have much of a broader economic impact. Meanwhile, central bankers have become confident enough in the general health of financial markets to debate pulling back on their $120 billion a month in bond buying stimulus.
But as confident as Mr. Williams is, some market participants are anxious. "That amount of cash flowing into the Fed is not healthy for the repo market," said Scott Skyrm of money market trading firm Curvature Securities, referring to the private market in which firms borrow and lend securities. He thinks the Fed needs to scale back its bond purchases, which he deemed the "most obvious and most effective way to bring cash back into the market" and out of the Fed's balance sheet.
There has also been a long-running debate over whether the Fed needs to tinker, as it has in the past, with the settings of its rate control tool kit and perhaps lift them, even as it leaves the current federal funds target rate in place. Raising the reverse repo rate might attract more money into the Fed, but raising the IOER rate might push up the fed-funds rate in its current range and lift other money markets. That in turn would make private money market investments attractive again compared with the zero return at the reverse repo tool.
Analysts at Evercore ISI think the Fed will tweak both the repo rate and IOER at the June 15 and 16 FOMC meeting, raising each by 0.05% to 0.05% and 0.15% respectively, because they believe key money market rates have fallen too far.
That said, the fed-funds rate, which traded at 0.06% on Friday, has been steady enough that some think there isn't a need to tweak either rate. They say that because the Fed isn't concerned about the volume of reverse repo activity and the funds rate is the main thing it cares about, that gives the central bank a reason to just leave the rate control tool kit settings where they are.
Write to Michael S. Derby at michael.derby@wsj.com
(END) Dow Jones Newswires
06-08-21 0544ET
