Fed cuts Interest On Excess Reserves (IOER) to negative
Banks are stashing $2.5 trillion dollars at the Fed where they earn 0.25%. The Fed has pondered lowering that rate many times and decided against but now might be the time for a change.
The minutes of the most-recent FOMC meeting said:
“[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage.”
If the Fed cuts that rate to zero or a negative rate it would be a massive monetary policy experiment. The initial reaction would be to sell bank stocks because they have warned about the repercussions, especially to money market funds.
The other reaction would be to sell the dollar, even if the Fed tapers. Whether the Fed buys $75B/month or $85B/month matters much less than those $2.5 trillion in deposits. The Fed wants to see those funds lent out productively and the rush into short-term paper would overwhelm selling on a taper. Fears about repercussions in the banking system would also spark USD/JPY weakness.
The flipside? After the dust settles that money will flow into the economy and help the economy. Overall, however, it will be mass confusion and it’s a good reason to stay on the sidelines.
There is also a significant difference between cutting rates to zero compared to switching them to negative.
What is the chance of an IOER cut?
It’s below 5% but not zero.
Former Fed vice chairman Alan Blinder argued for an IOER cut in the WSJ last week and said the comment in the minutes is a signal:
As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous. The Fed is famously given to understatement.
Why it won’t happen today
One reason is that the Fed wants to save it for later. St Louis Fed President Bullard said in late November a cut would be used for protection in a downturn. Others are worried about potential market disruptions and the Fed would likely need to do more preparatory work before any move.
That wouldn’t stop them from hinting at an IOER cut.