Tightening: Changing the Path

Chart of the Moment

Tightening: Changing the Path

A small but potentially key part of the Fed's balance sheet strategy

This spread in an arcane corner of money markets is the subject of heated debate amongst money market participants. Its interpretation could well lead to a change in the Federal Reserve’s quantitative tightening approach.

The spread between the interest on excess reserves (IOER) that banks get paid for parking money at the Fed and the effective fed funds rate (EFFR), at which institutions can borrow overnight in the open market, has been narrowing. Since the Fed moved to a target policy range in December 2008, the IOER has been set at the top of the target range, but as the spread between IOER and EFFR narrows, it has already forced the Fed to change its implementation policy.

Could This Change the Path of Quantitative Tightening?

Source: Bloomberg, 8/29/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


At the June Federal Open Market Committee (FOMC) meeting, the Fed raised the target range by 25 basis points (bps), but only raised the IOER by 20bps. The spread narrowing could be a function of a number of technical factors including increased demand for overnight funding by banks in connection with liquidity regulations, a pullback in lending in the EFFR market by federal home loan banks, increased arbitrage by European banks, or an excess of Treasury bills. Or, it could represent a scarcity of reserves and proof that quantitative tightening is having an impact on liquidity sooner than the Fed had expected. There are many opinions in the market about this and given the uniqueness of this tightening cycle it’s a spread worth monitoring.



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