RPT-U.S. Fed may need to do more to keep short-term rates above zero

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NEW YORK, April 13 (Reuters) - The Federal Reserve may need to go all out and lift the short- term rates it manages, analysts say, since its latest proposals to widen and expand open market operations to keep rates from going negative may fall short.

Short-term interest rates have been pressured all year by excess cash in the banking system, rising assets at money market funds as banks turn away deposits, and a shortage of bills and other cash instruments.

The U.S. overnight repo rate turned negative several times in March and February, dropping as low as -0.06% on March 29, its weakest since at least January 2003, Refinitiv data showed. It was last at 0.01%.

Bigger banks and other financial institutions have increasingly turned to the Fed for reverse repos and to park excess reserves. The Fed’s overnight reverse repo rate for non-banks is 0%, and the interest it pays banks for excess reserves (IOER) is 0.10%.

Seemingly intent on halting repo rates from going negative, the Fed last week announced it would allow more market participants to access its reverse repo window. In March, it raised the limits for every counterparty at its reverse repo facility to $80 billion, from $30 bln previously.

Lorie Logan, executive vice president at the New York Fed and the manager of the System Open Market Account (SOMA), said last week the Fed may adjust “administered rates” if “undue downward pressure on overnight rates emerges.”

The Fed, in the minutes of its March policy meeting, also said it could tweak those short-term rates.

“The fact that the FOMC is laying the groundwork so explicitly for a potential adjustment reinforces our belief that the Fed will be quicker to respond to downward technical pressure on overnight rates than in the past,” said Lou Crandall, chief economist, at Wrightson ICAP.

The worry, however, is about the sequencing of those Fed measures, even as investors grapple with a declining supply of Treasury bills. With market players pouring money into repo markets, the risk is that other short-term rates such as the U.S. secured overnight financing rate (SOFR), a reference rate the Fed has endorsed, will turn negative as well.


Under negative rates in the repo market, a bank or financial institution would be paying to lend cash. The Fed’s reluctance to let that happen stem from the effects negative rates would have on financial firms and on global eurodollar markets.

Volumes at the Fed’s overnight reverse repo window have gradually picked up this month, after the Fed raised the amount of cash counterparties can lend to it. Daily volumes have crossed $20 billion on average, compared with volumes of $14 billion on average in March, according to JP Morgan data.

In reverse repos, market participants lend cash to the Fed in exchange for Treasuries or other government securities, with a promise to buy them back.

Meanwhile, SOFR, the LIBOR replacement that measures the cost of short-term cash, has flatlined at 0.01% since March 11.

Analysts suspect the Fed is loath to let SOFR, a global dollar reference rate, go negative.

“There would be a lot of operational issues if SOFR were to print negative,” said Dan Belton, fixed income strategist, at BMO Capital. “It’s something that we have never experienced with Libor.”

That means the Fed would need to not only raise the IOER, which is used primarily by banks, but also the reverse repo rates.

The fed funds rate has remained steady at 0.07% over the last month.

The Fed has, in recent times, waited until its effective fed funds rate has moved within five basis points of either the upper or lower bound of its target range before tweaking administered rates. But that could change.

“In today’s environment, the Fed would be prepared to tweak its operational parameters if the funds rate falls to within six basis points of the floor,” said Wrightson’s Crandall.

Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley, Vidya Ranganathan and Andrea Ricci