The Fed Snakes the Pipes

June 18, 2021

Woman Looking At Male Plumber Cleaning Clogged Sink Pipe With Drained Cable In Kitchen


Chief Investment Officer, Jim Palmer, shares his thoughts on the June FOMC meeting this past Wednesday.
Jim Palmer, CFA, Chief Investment Officer

The best way to describe the function of Money Market Funds (MMF) and the money markets, in general, is as the plumbing of the financial system. When the plumbing gets clogged or drains too slowly, bad things can happen in your home and the financial markets. With rates near zero on MMF investments like repo and Treasury bills, the cash in the financial system was in danger of draining too slowly or becoming clogged. If the sink is draining too slowly in your home, it is best to be proactive and pour some Drano™ down the trap or snake the pipe. Otherwise, you may find yourself hosting extended family for Thanksgiving dinner with backed-up plumbing. Don’t ask me how I know; I just do. The Federal Reserve (Fed) took proactive steps at the June 16th meeting and metaphorically snaked the pipes by raising the Fed Reverse Repo Program (RRP) and Interest on Excess Reserves (IOER) five basis points (bps) to 0.05% and 0.15%, respectively. These moves should keep repo rates comfortably above zero and allow MMFs to continue absorbing excess deposits spilling out of the banking system.

A couple of other thoughts:

  • Most repo rates will move up to five bps starting Thursday morning. Over time, dealers will have to match the RRP or risk losing their funding base. I would expect dealer repo to trade at zero to one bps above RRP, a similar spread to the zero bound.
  • T-bill rates will rise, but perhaps very short rates will remain below five bps as some investors can’t or won’t invest in repo. We expect some additional curve to develop going out to one year, offering MMFs and direct purchasers an opportunity to add incremental yield.
  • Raising RRP and IOER does nothing to address the lack of supply in the front end of the curve for both prime and government assets. T-bill supply should rebound once the Treasury TGA drawdown is complete and the federal debt ceiling is resolved, hopefully by late summer.

As for the Fed’s core policies, the Federal Open Market Committee (FOMC) made no change to key policies at Wednesday’s meeting. Also, the June 16th statement had minor and non-substantive changes from the April 28th statement.

  • Fed funds target remains 0.00% – 0.25% (guidance is for rates to remain at these levels into 2023)
  • Asset purchases (QE) of $120 billion per month ($80 billion in U.S. Treasuries and $40 billion in agency Mortgage Backed Securities)

Perhaps the biggest story to come out of the meeting was the change to the Fed’s Dot Plot, which uses individual committee members’ forecast for future rate hikes.

  • No participants see a rate hike in 2021
  • Seven of 18 participants see a rate hike in 2022 (up from four in March) – Two see two hikes
  • 13 of 18 participants see rate hikes by 2023 (up from seven in March) – the median forecast suggests two rate hikes in 2023 – Two participants see six rate hikes by the end of 2023

I think Fed Chairman Powell gave a good description of why there were changes to the Dot Plot when suggesting participants are more comfortable that conditions to raise rates will be met earlier than expected. Seems reasonable to me.


Federal Reserve Press Release, June 16, 2021