Core Points - The Federal Open Market Committee (FOMC) is evaluating whether the federal funds rate remains the appropriate operating target for short-term interest rates, given the evolution of the financial system and money markets [1][2][3] Group 1: Historical Context and Evolution - The FOMC has historically adapted its operating targets to maintain influence over monetary conditions as the financial system has evolved, indicating a need for potential updates to the current target [3][4] - The transition to targeting the fed funds rate in the mid-1990s was a response to changes in the economy and financial system, making it a useful indicator of monetary conditions [12][19] - The Fed's operating targets have shifted over time, reflecting different economic goals, such as controlling inflation and stabilizing the macroeconomy post-World War II [10][11] Group 2: Changes in Money Markets - Since the mid-1990s, the money markets have undergone significant changes, with collateralized financing becoming more prevalent than uncollateralized interbank loans, diminishing the relevance of the fed funds market [4][21] - The volume of transactions in the fed funds market has decreased, with daily volumes now around $100 billion compared to over $4.5 trillion in repo markets, indicating a shift in market dynamics [28][29] - Regulatory changes post-Global Financial Crisis have further reduced the attractiveness of unsecured interbank lending, leading to a preference for secured funding [22][23] Group 3: Fragility of the Fed Funds Market - The connections between the fed funds market and broader money markets have become fragile, raising concerns about the effectiveness of the fed funds rate as an operating target [5][31] - The concentration of major lenders in the fed funds market, primarily the Federal Home Loan Banks (FHLBs), creates vulnerabilities that could impact monetary policy implementation [34][35] - A lack of trading volume in the fed funds market could lead to disconnection from other money markets, undermining its usefulness as a gauge for broader monetary conditions [36] Group 4: Alternative Operating Targets - The essay discusses potential alternative operating targets, including repo reference rates, which may provide more robust measures of monetary conditions than the fed funds rate [6][38] - Targeting a Treasury repo rate, such as the tri-party general collateral rate (TGCR), is proposed as a viable option due to its strong connections to broader money markets [52][60] - The Secured Overnight Financing Rate (SOFR) is also considered, but it may not provide as clean a gauge of liquidity costs as TGCR due to its combination of different market segments [57][58] Group 5: Benefits and Costs of Transitioning - Proactively transitioning to a different operating target could mitigate risks associated with the fragility of the fed funds market, although it would incur transition costs [68][69] - The effectiveness of policy transmission and the need for a well-developed understanding of the new target would be critical for successful implementation [70]

Core Insights - A key interest rate in the US financial system has surged to its highest level this year, surpassing the Federal Reserve's target range due to reduced liquidity, influenced by Treasury auction settlements and corporate tax payments [1][2]. Group 1: Interest Rate Movements - The Secured Overnight Financing Rate (SOFR) increased to 4.51% as of September 15, up from 4.42% the previous session, marking the largest rise since December 31 [2]. - The spread between SOFR and the effective fed funds rate widened to 18 basis points, the largest since December 26, with the fed funds rate at 4.40% as of September 12 [4]. Group 2: Market Conditions - Overnight financing rates for banks and asset managers have been rising as the Treasury rebuilds its cash reserves while the Federal Reserve reduces its balance sheet [3]. - Usage of the Fed's overnight lending facility has dropped to a four-year low, indicating a tightening liquidity environment [3]. Group 3: Federal Reserve Actions - The Federal Reserve has been unwinding its balance sheet since 2022 to reverse asset purchases made during the pandemic, aiming to minimize bank reserves at the central bank [6]. - Persistently high overnight rates may challenge the Fed's ability to continue its quantitative tightening without impacting liquidity in the financial system [5].

Core Insights - U.S. banks borrowed $1.5 billion from the Federal Reserve's Standing Repo Facility, indicating potential funding tightness coinciding with quarterly corporate tax payments [1] - The corporate tax deadline coincides with a significant Treasury security settlement, with approximately $78 billion in payments due to the Treasury [2] - The Secured Overnight Financing Rate (SOFR) rose to 4.42%, surpassing the Interest on Reserve Balances (IORB) of 4.40%, suggesting heightened demand for secured funding [3][4] Funding Conditions - The liquidity pressure observed is expected to be temporary and is typical for major Treasury coupon settlement dates and quarterly tax deadlines [5] - The Fed's Standing Repo Facility serves as a backstop for funding shortages, providing daily overnight cash in exchange for eligible collateral [1][5] - On June 30, financial institutions borrowed $11.1 billion from the SRF, marking the largest borrowing since its inception [5]