By Michael S. Derby
NEW YORK (Reuters) – The Federal Reserve appears likely to take a move on Wednesday to take money off its balance sheet, as it enters a more uncertain period in what many see as the final months in its bid to shrink its balance sheet .
Economists broadly expect the Fed to announce that it will cut the interest it pays to money market funds and others to park money in its overnight reverse repo facility (ONRRP) by a larger margin than the expected cut in its policy rate . While the federal funds rate target will be lowered by a quarter of a percentage point to between 4.25% and 4.50%, the reverse repo rate, or RRP, will drop to 4.25% from the current setting of 4.55% .
The Fed has previously adjusted the rate spread between Fed Funds and ONRRP, but those changes were intended to keep the Funds rate within the desired range or to navigate periods of near-zero interest rates. Harmonizing the spread now, Fed watchers think, could give the central bank some flexibility as it unwinds its bond holdings, known as quantitative tightening, or QT.
“It seems logical to me that at some point the [Federal Open Market] The Committee would like to return the overnight RRP offer rate to the lower end of the target range,” said Patricia Zobel, former manager of the New York Fed’s monetary policy implementation team and now head of macroeconomic research and market strategy at Guggenheim Investments.
Changing the interest rate “will be effective in encouraging people to find alternatives” to parking money at the Fed and will also likely lower money market rates, she said.
The Fed’s inverse repo rate is intended to provide a soft floor for short-term interest rates. Together with the interest paid to depository banks for reserves, this helps keep the Fed’s policy rate within its target range.
From near zero usage in the spring of 2021 to a peak of $2.6 trillion at the end of 2022, the reverse repo facility, which primarily takes cash from money market funds, has shrunk as the Fed has shrunk its balance sheet from a record $9 trillion . to $7 trillion by the summer of 2022 by allowing some of its holdings of government bonds and mortgage-backed securities to mature and not be replaced. However, for months, ONRRP totals have remained within a range and have yet to fall below $100 billion.
Fed officials who have weighed in on the issue have indicated that they would like to see ONRRP return to negligible levels, and that this is important for QT. Draining the Fed facility will mean that much of the excess liquidity has been removed and bank reserves can finally begin to decline, allowing QT to eventually come to an end.
