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Fed officials may talk technical rate move but delay acting for now - Metro US

Fed officials may talk technical rate move but delay acting for now

FILE PHOTO: The Federal Reserve Board building on Constitution Avenue is pictured in Washington

(Reuters) – A spate of volatility in money markets has stoked speculation the Federal Reserve may be forced into a technical adjustment to the levers controlling its benchmark interest rate to ensure that it does not fall too low, but few expect the central bank to act on the matter at this week’s meeting.

Interest rates in some short-term funding markets have dropped into negative territory on a handful of occasions recently, driven down by factors such as the Fed’s $120 billion a month of bond purchases, a surge in bank reserves and a big drop in the federal government’s cash stockpile as it doles out pandemic relief payments and tax refunds.

Fed officials are likely to discuss these sinking borrowing costs when they meet on Tuesday and Wednesday. Most economists and strategists, however, expect them to hold off for now in taking corrective action that would mean lifting the rate the Fed pays on bank reserves – known broadly by the acronym IOER.

Currently set at 0.1%, IOER helps the Fed keep its key policy rate, the federal funds rate, within the central bank’s target range, which was slashed to between zero and 0.25% a year ago when the coronavirus pandemic forced a broad economic shutdown. The fed funds rate has held steady at 0.07% since mid-February, although it has drifted lower since the start of the year along with other short-term rates.

Fed officials historically have taken corrective action when the fed funds rate is within 0.05 percentage point of the top or the bottom of the target range, said Mark Cabana, head of U.S. rates strategy at Bank of America.

So while officials are keeping an eye out, Cabana and most other Fed watchers see them waiting until the funds rate hits that trigger point.

That may happen in the weeks ahead, however, as last week’s enactment of the Biden administration’s $1.9 trillion COVID-19 relief package will send more cash into bank accounts and likely push short-term rates down further, Cabana said.

It’s not entirely out of the question that the Fed could move on the matter this week.

Given the Fed also faces a looming deadline on whether to extend an exemption granted a year ago on how bank capital requirements are calculated, which can have a big influence on the level of bank reserves held at the Fed, TS Lombard’s Chief U.S. Economist Steven Blitz sees a need to deal with it now.

“What the Fed is likely to do is tweak management of the balance sheet by raising IOER around 5 basis points, and adjust the SLR (supplementary leverage ratio) exemption that is ending,” Blitz wrote in a note.

Should it need to take action on IOER, the Fed would likely also raise the rate paid on overnight reverse repurchase operations, which acts as a floor on short-term interest rates. That rate is currently set at zero.

The Fed last made such an adjustment – which is seen as technical and not a change in its easy-money policy – in January 2020, when it nudged up IOER and the reverse repo rate but left its policy rate unchanged. The move worked: the funds rate had been trading at 1.55% – just 0.05 percentage point from the bottom of what was then the Fed’s target range of 1.50% to 1.75% – and it promptly rose closer to the middle of that range.

(Reporting by Jonnelle Marte; Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Dan Burns and Andrea Ricci)

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