The case for modernizing the FOMC’s operating target rate

A Federal Reserve official advocates for the FOMC to proactively modernize its operating target rate, transitioning from the federal funds rate due to its diminished relevance and fragility in evolved money markets. Citing post-GFC regulations and the ample reserves regime, the official proposes adopting a robust repo rate, specifically the Tri-Party General Collateral Rate (TGCR), as a more representative and effectively controllable target. This move, while not altering monetary policy strategy or balance sheet normalization, aims to ensure more stable and efficient policy implementation by aligning the target with the current center of gravity in U.S. dollar funding markets.

Analysis

A Federal Reserve official is publicly advocating for a significant modernization of the FOMC's monetary policy implementation, proposing a proactive shift away from the federal funds rate as the primary operating target. The core argument rests on the structural evolution of U.S. money markets, where the federal funds market's relevance has diminished significantly since the 1990s. Daily volume has shrunk to just over $100 billion, compared to over $4.5 trillion in the repo market, which the official identifies as the new center of gravity for dollar funding. Post-GFC regulations and the ample reserves regime have rendered unsecured interbank lending less attractive, turning the fed funds market into a concentrated arbitrage mechanism rather than a broad indicator of marginal funding costs. The official highlights the fragility of the current system, citing a September instance where repo rates rose by as much as 17 basis points amid Treasury settlements while the fed funds rate remained static at 4.33%, indicating a potential breakdown in policy transmission. To mitigate this risk, the proposal favors a transition to the Tri-Party General Collateral Rate (TGCR), a secured repo rate with over $1 trillion in daily volume, deeming it a cleaner and more robust target than the more widely adopted SOFR. This change is framed as a technical enhancement to policy implementation and financial stability, distinct from the FOMC's overall monetary strategy or balance sheet normalization plans.

Key Decisions for Investors

• Investors should closely monitor future FOMC communications and speeches for further commentary on changing the operating target, as this proposal signals an active, high-level debate on the plumbing of U.S. monetary policy.
• Fixed-income and money market participants should begin assessing the characteristics and liquidity of the Tri-Party General Collateral Rate (TGCR) relative to SOFR and the federal funds rate, as a potential shift to TGCR would directly impact short-term benchmark pricing and hedging strategies.
• The highlighted fragility of the fed funds market, evidenced by a 64% volume drop during the March 2023 banking stress, represents a tail risk for short-term funding; investors should remain aware of potential dislocations in money markets if stress events occur before a more robust target is adopted.