Powell Seeks to Assert Control Over Fed Funds With IOER Tweak

(Bloomberg) -- The Federal Reserve on Wednesday lowered the rate on one of the tools it uses to help control its benchmark even as it left unchanged the overall target range for the fed funds rate.

Fed officials decided to lower the interest paid on excess reserves by 5 basis points to 2.35 percent, effective May 2, although policy makers kept the overall target range for the fed funds rate unchanged at 2.25 percent to 2.50 percent. Fed Chairman Jerome Powell described it as a “small technical adjustment” that doesn't reflect any shift in stance of monetary policy.

The central bank's shift follows an increase in recent weeks in the effective fed funds rate within that band. The benchmark has been above IOER for more than a month and this week crept up to 2.45 percent, fueled in part by rates squeezing higher in other short-term funding markets.

For a story on the Fed's broader policy views, click here.

Whether the latest tweak from the Fed is effective in curbing pressure on the fed funds rate remains to be seen.

Key Insights

• Lowering the interest on excess reserves (IOER) rate could put downward pressure on the fed funds rate by further reducing the incentive for banks to park money at the central bank and instead lend in other short-term markets, such as fed funds.
• This is the third time in the past year that the Fed has increased the gap between IOER and the top of the central bank's target range, which is now 15 basis points above IOER.
• This latest adjustment echoes actions it took in June and December to keep in check the buoyant effective fed funds rate, although it's the first time that the Fed has shifted IOER in the absence of a change to the main target range. On previous occasions, the tweaks took place in conjunction with increase to the main target range, with IOER rising by just 20 basis points each time and the main range being boosted by 25 basis points.
• “It's important that we control the fed funds rate,” Powell said at his post-decision press conference. “That's just good monetary control. We have the tools to do that and we used them again today.”
• “We control only directly the fed funds rate and the transmission of the fed funds rate into other money-market rates has been good. That's important because it's broader financial conditions that matter. The Fed controlling the fed funds rate is important from that standpoint. I don't see us not controlling it,” the Fed boss said.
• Strategists including Bank of America's Mark Cabana and JPMorgan's Alex Roever said before the move that they believe the best way for the Fed to control short-term interest rates and curb funding pressures is to establish a standing repurchase agreement facility.
• “In the end, I think the whole IOER model was flawed to begin with, and when we get to these extreme levels of change in liquidity, it's not as adequate to contain the funds rate and eventually the Fed will have to introduce a new policy tool,” Guggenheim Partners' Scott Minerd said in a Bloomberg Television interview. “I'm not sure that they'll do it through repo, but that would be the simplest, most straightforward way for them to go.”

Market Action

• Treasuries extended their gains after the Fed tweak before reversing course during Powell's press conference. The 10-year yield fell as much as 5 basis points to 2.45 percent, before rebounding to around 2.51 percent after Powell commented that some of the reasons behind current low inflation appear to be “transient or idiosyncratic.”
• The Bloomberg dollar index fell as much as 0.3 percent before rebounding as much as 0.2 percent during the press conference.

Get More

• A QuickTake about the Fed's fight for control of its key interest rate
• Speech from Lorie Logan, senior vice president in the markets group at the Federal Reserve Bank of New York
• A story on the possibility of a new repo tool

--With assistance from Katherine Greifeld, Scarlet Fu and Tom Keene.

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net

To contact the editor responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net

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