Wall Street questions Fed’s intentions as tool rate cut appears likely

Wall Street is buzzing as the Federal Reserve prepares to tweak its overnight reverse repo (RRP) facility rate, a move expected to drop it by 5 basis points.

This seemingly small adjustment, rumored to come next week, could move billions in cash flows and stir up money markets. Traders and analysts are asking the same question: What’s the Fed really up to?

The RRP rate, now sitting at 4.55%, is five basis points above the lower limit of the central bank’s policy target range of 4.5% to 4.75%. While the Fed labels this adjustment as “technical,” skeptics aren’t buying it.

With balances at the RRP facility already down $2.4 trillion from their December 2022 peak, the timing feels off. Why make a change now when usage has plateaued at roughly $175 billion?

Liquidity, or just optics?

The Federal Reserve has been chipping away at excess liquidity since it began quantitative tightening. The RRP facility, which acts as a sponge for extra cash in the system, has seen massive outflows over the past year. But some experts say this isn’t about liquidity at all.

Barclays says the adjustment is purely technical, meant to align the RRP rate with the lower end of the federal funds target range. In other words, it’s housekeeping. Yet firms like Bank of America and Citigroup are scratching their heads, questioning the logic.

Mark Cabana of Bank of America called the timing “perplexing,” noting that the adjustment would lower repo and Treasury bill rates, but not much else.

Jason Williams at Citigroup shares the confusion. “The market isn’t signaling an urgent need for this move,” he said. “If it were, the futures curve would show it, and that’s not happening.”

The Fed hasn’t touched the RRP rate since June 2021, when a dollar surplus pushed short-term funding rates to the floor. Back then, $521 billion was parked in the facility.

Wall Street’s breakdown of the Fed’s playbook

Wrightson ICAP’s Lou Crandall thinks the Fed could act as early as next week or delay until January. His view? The Fed might want to separate the RRP adjustment from its expected quarter-point cut to the main policy rate. “It’s all about timing,” he said.

But Morgan Stanley’s Martin Tobias isn’t so sure this adjustment will have much impact. He sees the move as part of the Fed’s effort to keep quantitative tightening on track while maintaining money market stability. “The Fed funds rate should stay 8 basis points above the lower range, even after the tweak.”

Meanwhile, Bank of America is unconvinced the adjustment is necessary. The firm argues that liquidity conditions don’t justify a rate cut now. But Deutsche Bank takes a different view, suggesting the move could ease upward pressure on short-term rates and nudge RRP balances lower.

TD Securities is focused on what happens next. The company predicts the Fed will end quantitative tightening altogether by March 2025, with this RRP adjustment serving as a temporary fix. They expect a 5 basis point drop in the RRP rate, which would trickle down to SOFR and fed funds rates.

Mixed outcomes ahead

Not everyone sees this adjustment as a big deal. JPMorgan Chase’s Teresa Ho said the current low balances at the RRP facility mean a rate cut might not move the needle much. “If the Fed wants to make a real impact, they’d need to adjust the interest on reserve balances (IORB) rate,” added Srini Ramaswamy, her colleague.

Still, some strategists think the adjustment could ripple through repo and Treasury markets. Deutsche Bank predicts partial pass-through effects, with repo rates falling slightly after the change. Barclays’ Joseph Abate described the move as a return to pre-pandemic norms, when the RRP rate matched the lower end of the federal funds range.

There’s also speculation about how this tweak might influence behavior in 2025. With Treasury bill supply expected to shrink due to debt ceiling negotiations, counterparties could park more cash in the RRP facility. That could drive balances higher, counteracting the Fed’s liquidity tightening efforts.

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