
The Federal Reserve is expected to lower the rate on one of its tools used to manage the key policy benchmark. However, some market participants on Wall Street express uncertainty regarding the rationale for this impending adjustment.
Most strategists believe that the Fed will cut the offering rate on its overnight reverse repo facility (RRP) by 5 basis points, potentially happening as early as next week, in line with expectations for a quarter-point reduction in the benchmark rate. The current RRP rate is at 4.55%, which is five basis points above the lower end of the Fed’s target range of 4.5% to 4.75%.
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These anticipations follow indications from policymakers that they see value in a “technical adjustment” to the RRP rate, aligning it with the lower end of the federal funds rate target range, as noted in the minutes from the November meeting. While such an adjustment could exert downward pressure on money market rates, it may also impact the volume of funds deposited at the Fed facility, leading to discussions on Wall Street about the benefits of this change.
Since peaking in December 2022, balances at the facility—a gauge of excess liquidity in the financial system—have fallen by approximately $2.4 trillion, although the pace of decline has recently moderated. On Wall Street, the total cash held at the RRP has been viewed as an essential indicator as the central bank continues to shrink its balance sheet through a process known as quantitative tightening.
Barclays Plc views aligning the RRP with the lower limit as a “purely technical” move, according to insights from the meeting minutes. However, companies like Bank of America, TD Securities, and Citigroup are questioning the necessity of such a policy change at this time, especially with around $175 billion currently resting at the RRP. Additionally, usage of the facility is expected to increase organically in the first half of 2025 due to anticipated reductions in Treasury bill supply related to the debt ceiling, which may lead counterparties to deposit more funds at the RRP.
The last modification to these tools occurred in June 2021 when the rate on the RRP facility was raised to address a surplus of dollars in the short-term funding markets that significantly exceeded the quantity of available investable securities, putting downward pressure on front-end rates, while the Fed’s key benchmark remained unchanged. At that time, $521 billion was parked in the overnight RRP facility.
Expert Insights
Wrightson ICAP (Lou Crandall, December 9 report)
- Wrightson now anticipates that the Fed will lower the RRP rate by 5 basis points either next week or during the January meeting, despite Crandall’s previous belief that such an adjustment was still several months away.
- The timing of the adjustment may depend on the Fed’s forthcoming policy actions, as the central bank could choose to separate the rate cut from the technical adjustment.
- They do not expect significant ripple effects on unsecured rates, mainly because the fed funds market largely reflects overnight cash that Federal Home Loan Banks temporarily hold at foreign institutions for liquidity needs. The arbitrage spread has remained stable at 7 basis points for much of the past three years, and a consistent spread on fed funds-interest on reserve balances is anticipated.
- The firm predicts that both the Secured Overnight Financing Rate and Tri-Party General Collateral Rate will decline by 4 basis points in relation to the Fed’s target range but acknowledges the potential for a full pass-through of 5 basis points.
Morgan Stanley (Martin Tobias, December 6 report)
- Analysts forecast the RRP rate will be reduced by 5 basis points at the December meeting, viewing the adjustment as a way to bring the rate back in line with the lower bound of the federal funds target range established when the facility was introduced as a monetary policy tool.
- The reference to a technical adjustment in the November FOMC minutes, alongside a staff briefing concentrating on balance-sheet management, suggests that quantitative tightening and the efficiency of money markets are priority areas.
- It is expected that the fed funds rate will stay 8 basis points above the lower bound—currently at 4.5%—as it seems unlikely that fed funds volumes will rise sufficiently to exert downward pressure on fed funds.
Citigroup (Jason Williams, December 6 report)
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- Estimating when the Fed might make an adjustment to the RRP is complex, as gauging the necessity for it is challenging, according to Williams. The Fed may not need to modify the RRP rate until the January meeting (or even later into 2025), especially if the debt ceiling remains a primary concern.
- If the market had expected a December adjustment, the SOFR/fed funds Dec/Jan futures curve would have steepened more notably. This would impact about 10 days this month and approximately 25 days in January; the futures curve should have steepened by 0.4 basis points for each 1 basis point shift in SOFR/fed funds, but such steepening did not occur.
- Whenever the Fed decides to lower the RRP rate by 5 basis points, tri-party repo rates are anticipated to decrease by the same margin, along with bilateral rates, although a slight adjustment of only 3 to 4 basis points may happen as dealers might take an additional basis point or two. Fed funds are expected to continue trading 7 basis points lower than the interest on reserve balances (IORB) rate.
Bank of America (Mark Cabana, December 5 remarks)
- There is not a strong belief that the Fed will adjust the RRP rate in December; although it seems probable, as “the rationale for the move is rather perplexing,” Cabana noted during a press call discussing BofA’s 2025 outlook.
- If the Fed moves forward with a 5 basis point adjustment to the RRP rate, it will result in lower repo and T-bill rates, with the Secured Overnight Financing Rate declining correspondingly.
JPMorgan Chase & Co. (Teresa Ho, Srini Ramaswamy, December 2 remarks)
- “Decreasing the RRP rate by five basis points will effectively bring SOFR back toward the midpoint of the target range,” Ho remarked at a media roundtable focused on its 2025 forecast.
- “While it is possible that reducing RRP rates may not significantly impact given the low balances at RRP, a drop in IORB could be beneficial,” Ramaswamy added.
TD Securities (Gennadiy Goldberg, December 2 report)
- The Fed’s inclination to lower the offering rate on the RRP facility—potentially in December—could offer the central bank a strategy to avoid reserve shortfalls “for a while longer.”
- The firm still anticipates the Fed will cease its QT altogether by March 2025, viewing the RRP adjustment as a temporary measure.
- A 5 basis point reduction in the RRP rate is expected, while interest on reserve balances will likely stay unchanged, resulting in a 5 basis point decrease in SOFR and approximately a 4 basis point drop in the fed funds rate; read more
Deutsche Bank (Steven Zeng, Matthew Raskin, Brian Lu, December 2 report)
- The forthcoming adjustment—likely in December—aims to achieve two goals: alleviating upward pressure on money market rates and facilitating further reduction of RRP balances.
- Repo rates should decline following the adjustment, with a “partial” pass-through to the effective fed funds rate anticipated.
Barclays (Joseph Abate, Nov. 27 report)
- “The rationale for decreasing the RRP rate is strictly technical,” Abate asserted. “It is meant to restore the rate to its pre-pandemic level at the bottom of the fed funds band.”
- The Fed is expected to maintain the interest on reserve balances (IORB) rate at 4.65%, which will widen the gap between the two rates to 15 basis points.
- Ultimately, a 5 basis point cut in the RRP rate is projected to lower all repo rates similarly, “but it’s crucial to note that this reduction will not change market fundamentals,” as balance sheet capacity remains limited, and demand for all asset funding stays strong; read more
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