Odd Lots

Lots More with Joe Abate on the Fed's New Target and the Rising Price of Money

October 3, 2025

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  • The Federal Reserve's traditional method of targeting the Fed funds rate, which relies on interbank lending, has become less active due to the ample reserve regime implemented since 2008, turning the Fed funds rate primarily into a communication device. 
  • Dallas Fed President Lorie Logan has proposed that the Fed should move away from targeting the Fed funds rate to a market-based instrument like the tri-party repo rate to gain a better feedback mechanism on liquidity management as reserves decline. 
  • The rising price of liquidity, evidenced by recent repo rate increases, is attributed to the shrinking supply of reserves, driven by Quantitative Tightening (QT) and the Treasury Department maintaining a higher cash balance at the Fed. 

Segments

Fed Policy Mechanics Overview
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(00:00:30)
  • Key Takeaway: The introduction sets up the core issue: the mechanics of how the Fed tightens policy via the federal funds market are nuanced and potentially outdated.
  • Summary: The episode of Odd Lots, “Lots More with Joe Abate on the Fed’s New Target and the Rising Price of Money,” focuses on the intricacies of short-term funding markets. The context highlights that the Fed traditionally uses the federal funds market to adjust benchmark interest rates. A recent argument by Dallas Fed President Lorie Logan suggests this target mechanism may need updating.
Fed Rate Communication vs. Plumbing
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(00:02:43)
  • Key Takeaway: The Fed uses the Fed funds rate primarily to communicate policy intentions, but the actual market rates can sometimes deviate from the target, necessitating an understanding of the underlying plumbing.
  • Summary: Short-term interest rates exist as a constellation, and while the Fed influences them, they do not always converge perfectly to the target. The Fed funds rate serves as the primary barometer for communicating policy intentions and forward guidance via tools like the dot plot. The mechanical transmission of these intentions to broader rates like mortgages depends on this overnight rate linkage.
Fed Funds Target Debate Origins
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(00:09:55)
  • Key Takeaway: Lorie Logan’s speech advocating for a new rate target stems from the Fed funds market becoming a ‘Roman lake’ with low activity, making it a poor barometer for liquidity management.
  • Summary: The Fed funds market has devolved because the ample reserve regime, established around 2008 due to Quantitative Easing (QE), eliminated the need for banks to borrow reserves. This lack of activity means the market primarily functions as a communications device rather than a true indicator of liquidity stress. A market-traded instrument, like the tri-party repo rate, would provide a better feedback loop on liquidity management.
Cost of Ample Reserves
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(00:11:47)
  • Key Takeaway: While ample reserves increase bank safety by providing immediately available liquidity, an overstock can lead to banks holding excessive, low-cost reserves, crowding out other assets like loans.
  • Summary: Running an inefficient balance sheet with excessive reserves implies banks hold more liquidity than necessary because the cost is low. This overstocking can lead to balance sheets becoming overly skewed toward cash and securities rather than loans, as seen when loan demand was weak during QE. When rates rise, this structure can cause volatility, as seen by rapid deposit outflows in March 2023.
Tri-Party vs. SOFR Benchmark
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(00:17:47)
  • Key Takeaway: The tri-party repo rate is preferred over SOFR as a potential new target because the tri-party market is a pure financing market, whereas SOFR includes the bilateral repo market, leading to bifurcated market equilibria.
  • Summary: The tri-party market involves dealers raising cash from providers like money market funds, representing a focused financing equilibrium. SOFR, by contrast, incorporates the bilateral repo market, where participants might be seeking specific securities (the ‘right shoe’) rather than just general financing. This difference creates two distinct equilibria, potentially obscuring the true market signal in a volume-weighted average like SOFR.
Prospects for Fed Target Change
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(00:19:23)
  • Key Takeaway: A change in the Fed’s targeted instrument is likely sooner than many expect, given Lorie Logan’s influential background at the New York Fed’s implementation desk, though it is unlikely within the next two years.
  • Summary: The Fed has a history of changing how it communicates its targeting, moving from subtle operational cues to explicit publication of the target rate. The successful track record of achieving the Fed funds target has reduced the need for direct daily intervention compared to pre-1994 operations. Logan’s proposal carries weight due to her experience with the Fed’s monetary policy mechanics.
Liquidity Price and Reserve Decline
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(00:22:20)
  • Key Takeaway: The price of liquidity is increasing because the ample supply of reserves is actively falling as the Fed’s balance sheet shrinks past the Reverse Repo (RRP) program capacity, disproportionately affecting foreign banks.
  • Summary: The decline in reserves is driven by Quantitative Tightening (QT) and the Treasury building up its cash balance at the Fed, which drains reserves. Initially, this decline was absorbed by the RRP program, which mopped up excess liquidity. Now, further balance sheet shrinkage directly reduces bank reserves, increasing the cost of funding for entities like foreign banks active in the Fed funds market.
Stable Coins and Payment Demand
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(00:24:43)
  • Key Takeaway: Stable coins, structured like money market funds, are theoretically intended to increase demand for short-duration assets like Treasury bills, potentially offsetting term debt issuance, but they primarily substitute for currency held offshore.
  • Summary: If stable coin demand rises, they should purchase short-duration assets like T-bills or repo, supporting Treasury funding needs. However, payment tokens are viewed as closer substitutes for physical currency than bank deposits. Significant demand for payment tokens is expected to originate outside the US, particularly in underbanked economies or for remittances, where they substitute for cash held abroad.
Global Swap Spread Widening
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(00:28:47)
  • Key Takeaway: The global widening of swap spreads reflects a realization among investors that fiscal policy in major economies is moving in an unsustainable direction, demanding a higher premium for holding government debt.
  • Summary: Swap spreads are widening across multiple countries (Australia, Japan, Canada) due to a general global concern over increasing government debt levels. This widening represents investors demanding a higher premium for holding government debt given the fiscal outlook. This is not characterized as ‘bond vigilanteism’ but rather a market realization regarding fiscal sustainability.