The U.S. Federal Reserve’s top markets official said the first interest-rate hike in seven years has gone smoothly, with the central bank’s new mechanism for raising rates from near zero making a successful debut.
The overnight reverse repurchase program (ON RRP) allows approved counterparties — predominantly money market funds — to park cash overnight at the Fed in exchange for Treasury securities, with the Fed paying a fixed rate of interest on the cash. By increasing the rate it pays on investors’ cash, the Fed induces other interest rates, which compete for the same money, to also rise.
To implement the rate hike, the central bank in December lifted the $300 billion cap on available use of the RRP facility, giving it an effective capacity of around $2 trillion.
Simon Potter, head of the markets group at the Federal Reserve Bank of New York, said in a speech Monday that the new tools have provided “excellent control” over money market rates.
“The policy rate increase has passed through to other money market rates, suggesting that the increase is affecting broader financial conditions as expected and intended,” he said at the School of International and Public Affairs at Columbia University.
Under its old monetary policy, the Fed controlled the key federal funds rate by modulating the supply of reserves that banks kept in cash or held in an account at the Fed. The New York Fed devised the overnight RRP program because the Fed’s balance sheet had grown significantly since the financial crisis, leaving it awash in reserves.
The new system pays “banks 1 percent interest on their Fed accounts, so banks have little reason to lend at lower rates,” the New York Times explained.
At its peak in late December, investors parked $475 billion in the RRP and the current level stands at $54 billion. The Fed has said it will reduce the cap but, according to the Financial Times, “Potter is unsure of the appropriate level it should move to, fearful that it could push rates lower.”