By Michael S. Derby
(Reuters) – The Federal Reserve adjusted a key part of its interest rate control toolbox on Wednesday, cutting the interest rate it offers on its reverse repo facility by more than it cut the federal funds rate.
The Fed said the reverse repo rate will now be 4.25% from the previous level of 4.55%, marking a easing of 30 basis points, while it cut the federal funds target rate by a quarter of a percentage point to between 4.25% and 4.5%. .
Analysts believe the largely expected adjustment is an attempt by the Fed to draw money from a facility widely seen as indicative of excess liquidity in the financial system.
The interest the Fed pays for its overnight reverse repo facility (ONRPP) is available to money market funds and others to park money at the central bank in what is essentially a collateralized loan to the Fed. The ONRPP rate is intended to put a soft floor under all short-term interest rates.
The rate the Fed pays depository banks to lend cash rose from 4.65% to 4.4%. Both interest rates are combined to keep the target federal funds rate range within the desired level.
The Fed has previously made technical adjustments to the ONRRP rate, largely to ensure that it maintains firm control over the federal funds rate range. However, this change could have wider consequences as it is likely to make the reverse repo facility a less attractive place to hold cash, which in turn will encourage users of the instrument to seek better returns in the private market .
The reverse repo facility has gone from negligible use in the spring of 2022 to a peak of $2.6 trillion at the end of 2022. The facility has been shrinking as the Fed has divested bonds to reduce the size of its balance sheet, which has fallen since 2022. peak from $9 trillion to the current $7 trillion, but in recent weeks the facility appears to be stabilizing.
That’s not what some Fed policymakers want, as officials like Lorie Logan, head of the Dallas Fed, have noted that they expect reverse repo balances to drop to near-zero levels. This would almost certainly mean that continued efforts to reduce the size of Fed investments would erode bank reserves, marking the final phase of the extinction of pandemic-era levels of Fed market support.
There is still significant uncertainty about the endgame of the Fed’s balance sheet reduction, with markets looking for a stop point in May. Flushing cash from the reverse repo facility should help make this forecast a reality, although year-end market volatility and government financing issues next year could complicate that process.
(Reporting by Michael S. Derby; Editing by Andrea Ricci)
