The Federal Reserve is expected to lower the rate on one of its tools aimed at managing the primary policy benchmark. However, certain stakeholders on Wall Street are questioning the rationale behind this possible adjustment.

Most strategists anticipate that the Fed will cut the offering rate on its overnight reverse repo facility (RRP) by 5 basis points, potentially as early as next week, aligning with the expectations of a quarter-point reduction in the benchmark rate. Currently, the RRP rate is at 4.55%, which is five basis points above the lower limit of the Fed’s target range of 4.5% to 4.75%.

These anticipations arise after policymakers indicated their awareness of the advantages of a “technical adjustment” to the RRP rate, which would align it with the lower end of the target range for the federal funds rate, as highlighted in the minutes from the November meeting. Although such a modification could exert downward pressure on money market rates, it may also affect the volume of funds held at the Fed facility, sparking discussions on Wall Street around the potential benefits of such a change.

Since peaking in December 2022, balances at the facility—a gauge of excess liquidity within the financial system—have declined by approximately $2.4 trillion, although the pace of decline has recently tapered off. Within Wall Street circles, the total cash at the RRP has long been regarded as a key indicator as the central bank continues to reduce its balance sheet through a strategy known as quantitative tightening.

Barclays Plc views the alignment of the RRP with the lower limit to be a “purely technical” adjustment, based on information gathered from the minutes. In contrast, firms like Bank of America, TD Securities, and Citigroup are confused about the necessity of such a policy shift at this moment, especially with around $175 billion currently deposited at the RRP. Moreover, usage is expected to increase organically in the first half of 2025 due to projected declines in Treasury bill supply stemming from the debt ceiling, which may encourage counterparties to deposit more cash at the RRP.

The last modification to the tools occurred in June 2021 when the rate on the RRP facility was elevated in response to an oversupply of dollars in short-term funding markets significantly outpacing the availability of investable securities, which pressured front-end rates downwards, despite the stability of the Fed’s key benchmark. At that time, $521 billion was kept parked in the overnight RRP facility.

Expert Insights

Wrightson ICAP (Lou Crandall, December 9 report)

• Wrightson now anticipates that the Fed will lower the RRP rate by 5 basis points either next week or during the January meeting, despite Crandall’s previous assumption that such a change was “likely still some months away.”
• The timing for this adjustment may depend on the Fed’s upcoming policy decisions, as the central bank might choose to decouple the rate cut from the technical adjustment.
• They do not expect any significant ripple effects on unsecured rates, mainly because the fed funds market largely reflects overnight cash that Federal Home Loan Banks temporarily hold at foreign institutions for liquidity needs. The arbitrage spread has remained stable at 7 basis points for most of the last three years, and an unchanged spread on fed funds-interest on reserve balances is predicted.
• The firm forecasts that both the Secured Overnight Financing Rate and Tri-Party General Collateral Rate will decrease by 4 basis points in relation to the Fed’s target range, but acknowledges the possibility of a full pass-through of 5 basis points.

Morgan Stanley (Martin Tobias, December 6 report)

• Analysts foresee a 5 basis points reduction in the RRP rate at the December meeting, viewing the adjustment as a means to realign the rate with the lower bound of the federal funds target range that was established when the facility was created as a monetary policy instrument.
• The mention of a technical adjustment in the November FOMC minutes, coupled with a staff briefing focused on balance-sheet management, suggests that quantitative tightening and the operations of money markets are prioritized.
• It is expected that the fed funds rate will remain 8 basis points above the lower limit—currently set at 4.5%—as it is unlikely that the fed funds volumes will rise sufficiently to exert downward pressure on fed funds.

Citigroup (Jason Williams, December 6 report)

• Estimating when the Fed might implement an RRP change is challenging, as gauging the necessity for it is difficult, according to Williams. The Fed may delay adjusting the RRP rate until the January meeting (or even into 2025), particularly if the debt ceiling remains a significant issue.
• If the market had expected a December adjustment, the SOFR/fed funds Dec/Jan futures curve would have steepened more considerably. This would have affected about 10 days this month and roughly 25 days in January; ideally, the futures curve should have steepened by 0.4 basis points for each 1 basis point movement in SOFR/fed funds, but this steepening did not materialize.
• Whenever the Fed decides to reduce the RRP rate by 5 basis points, tri-party repo rates are expected to follow suit, as will bilateral rates, though there could be a slight adjustment of only 3 to 4 basis points as dealers may take an extra basis point or two. Fed funds are expected to continue trading 7 basis points below the interest on reserve balances (IORB) rate.

Bank of America (Mark Cabana, December 5 remarks)

• There is insufficient conviction that the Fed will adjust the RRP rate in December—though it seems likely—as “the rationale behind the move is quite perplexing to us,” Cabana remarked during a press call discussing BofA’s outlook for 2025.
• Should the Fed go ahead with a 5 basis points adjustment to the RRP rate, it will likely reduce repo and T-bill rates, with the Secured Overnight Financing Rate experiencing a corresponding decline.

JPMorgan Chase & Co. (Teresa Ho, Srini Ramaswamy, December 2 remarks)

• “Reducing the RRP rate by five basis points will effectively place SOFR back in the middle of the target range,” Ho asserted during a media roundtable focused on its 2025 forecast.
• “It may be that lowering RRP rates won’t have much impact given the low balances at RRP, but a reduction in IORB could yield benefits,” Ramaswamy noted.

TD Securities (Gennadiy Goldberg, December 2 report)

• The Fed’s inclination to lower the offering rate on the RRP facility—potentially in December—might provide the central bank with a means to avoid reserve shortfalls “for a while longer.”
• The firm still expects the Fed to cease its quantitative tightening entirely by March 2025, considering the RRP adjustment to be a temporary fix.
• A 5 basis points drop in the RRP rate is anticipated, with interest on reserve balances likely remaining unchanged, resulting in a corresponding 5 basis point decline in SOFR and roughly a 4 basis point decrease in the fed funds rate; read more

Deutsche Bank (Steven Zeng, Matthew Raskin, Brian Lu, December 2 report)

• The upcoming adjustment—likely in December—aims to achieve two goals: alleviating upward pressure on money market rates and facilitating a continued reduction of RRP balances.
• Repo rates are expected to decline following the adjustment, with a “partial” pass-through to the effective fed funds rate anticipated.

Barclays (Joseph Abate, Nov. 27 report)

• “The justification for reducing the RRP rate is strictly technical,” Abate stated. “It is aimed at restoring the rate to its pre-pandemic level at the bottom of the fed funds range.”
• The Fed is expected to maintain the interest on reserve balances (IORB) rate at 4.65%, which will widen the gap between the two rates to 15 basis points.
• Overall, a 5 basis points decrease in the RRP rate is projected to lower all repo rates similarly, “but it is essential to understand that this reduction will not change market fundamentals,” given that balance sheet capacity remains constrained and the demand for all asset funding is still robust; read more

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