Further, the prevalence of standing business relationships has seemed to mean that in practice transitory shocks can have more permanent effects on pricing. Indeed, despite a recent decline in repo rates, the effective federal funds rate has remained fairly stable at nine basis points below the top of the range. 30 Moreover, there have been various other recent shocks that may have influenced money market flows and structure, such as those from recently enacted tax reform measures. There are various opinions in the market on how things go from here. Some believe that we might see federal funds rates remain at a similar spread to IOR or rise somewhat closer to it—for example, due to a forecasted seasonal increase in net Treasury bill issuance heading into 29 In particular on June 20 and 21 our market intelligence and analysis of data suggest that LCR-motivated borrowing from FHLBs by a few banks placed modest upward pressure on traded rates in the federal funds market. A contributing factor was a decline in funds supplied into the market from the FHLBs, due to an increase in demand for advances around the mid-month tax date. Data on historical traded rates in the Eurodollar market are published with a quarterly lag as part of the New York Fed’s Quarterly FR 2420 Summary Statistics release.
I see this as a reasonable possibility, and therefore I think it might be possible that the decline in reserve balances has pushed up overnight rates a bit over time. 17 At this point, I see no evidence that we are at, or close to, the “steep” portion of the demand curve. 18 Let’s run through some places where evidence of such a possibility might be found. To begin with, if we were closing in on the “steep” part, I might have expected to see more above-IOR lending in the unsecured overnight markets, as at least some banks each day found themselves short of reserves and had to borrow them from another bank. In fact, the amount of such above-IOR lending remains low as a share of the overnight bank funding market, as shown in Figure 9. 19 I might also have expected to see shifts in bank payments behavior—for example, more daylight overdrafts or more effort by banks to “optimize” their payment flows— but I have not seen this either. But, most fundamentally, I might have observed a day-to-day relationship between shifts in the stock of reserves and overnight interest rates. Figure 10 shows a scatterplot of daily changes in reserve balances against daily changes in the spread between the IOR rate and the effective federal funds rate; there is no visible relationship. 16  The classic paper on this topic is Poole (1968).