The Fed finally raised the overnight reverse repo rate.
Economists tell us that monetary policy works with a lag. The idea is that it takes time for changes to take hold, especially broad shifts like altering the supply of money. But it also could apply to how slow policymakers generally are to make decisions in the first place.
While the speed with which the Federal Reserve responded to the pandemic was excellent, officials pondered adjusting the reverse repurchase agreement rate for too long. The overnight markets haven’t been working as they should for some time now. At the June Federal Open Market Committee meeting, they finally increased the Reverse Repo Facility and the Interest on Excess Reserves by 5 basis points each, to 5 and 15 basis points, respectively. The money markets breathed a sigh of relief, but shouldn’t have needed to hold their breath for so long.
It seems the Fed wanted to make the change in phases for maximum impact: first increase the total amount of available repo from $30 billion to $80 billion, then expand number of counterparties by lowering the requirements for minimum asset size, then bump up the administered rates. But was that really necessary? The markets easily could have handled implementing all of these in one week. With banks so flush with cash they want nothing to do with new deposits, the money markets could have been helping investors for several months now. If I sound ungrateful, I am not. Since the move, the industry has seen higher gross yields, and overnight operations are much smoother. For instance, banks again have incentive to sponsor repo transactions. But the Fed’s caution was overdone.
The real drama of the meeting was in the dot plot’s suggestion that the fed funds liftoff might come earlier—welcome news, of course. But the theater has just begun. Fed members have started to diverge in their opinions of when this, and tapering of asset purchases, should happen. Differences surely will become more pronounced as the year progresses and new readings on inflation and GDP emerge. It won’t be long before we see hawk and dove scorecards, and it will test Chair Jerome Powell’s diplomacy to avoid dissent.
It’s worth noting the details of the Summary of Projections beyond rates. Participants' PCE projections for 2021 rose from 2.4% in the March meeting to 3.4%, and they now forecast a GDP growth rate of 7% for this year compared to their previous call of 6.5%. But both measures retreat soon after, with inflation floating above 2%. Employment remains the wild card. If companies have found they can do without as many employees as before due to reorganization, automation or productivity from remote work, it might be hard for the unemployment rate to stick the landing that the Fed judges want to see. (Yes, I am excited about the Summer Olympics!)
Cash management purchases throughout the industry did not measurably change over June. Bill supply still is low and will be until after a new debt ceiling is set. The commercial paper market has rebounded somewhat as companies’ finances are normalizing and typical funding needs have returned after the splurge in bond issuance last year. Supply in the tax-free money markets was high in June, typical of this time of the year. Most municipalities, states and cities continue to do well fiscally, with solid budgets due in part to the distribution of stimulus funds.
The weighted average maturities of our money market funds remain in target ranges of 35-45 days for government and 40-50 days for prime and municipal.