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Fed's Kaplan hopes technical change from Fed may clarify benchmark rate

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Fed's Kaplan hopes technical change from Fed may clarify benchmark rate

Federal Reserve Bank of Dallas President Robert Kaplan said May 25 he hopes an upcoming technical change from the Fed may help reverse a recent trend in the central bank's benchmark rate, according to Reuters.

The federal funds rate rate is currently set at a target range of 1.5% to 1.75%, but it has recently settled along the higher end of the two figures. The effective rate, for example, has been 1.70% this week.

The Federal Open Market Committee discussed the issue this month, according to minutes of its meeting released May 23. Lorie Logan, senior vice president of the New York Fed's markets group, said the trend has largely been driven by higher rates on repurchase agreements as the Treasury Department issues more government debt.

"Higher rates had reportedly made repos a more attractive alternative investment for major lenders in the federal funds market, thus reducing the availability of funding in that market and putting some upward pressure on the federal funds rate," the minutes said.

To help drive the effective federal funds rate away from the higher end of the range, Logan outlined a technical change that FOMC participants "generally agreed" they should follow the next time the committee increases rates. The FOMC is expected to hike rates again when it meets in June.

The change would lower the rate that the Fed pays banks for interest on excess reserves that they hold at the central bank above required reserve levels. Right now, the rate is set at the top level of the federal funds rate range. The change would lower it to 5 basis points below the top figure.

Kaplan told reporters the adjustment "will help us better set the fed funds rate, and I'd be hopeful that this adjustment will address that issue," Reuters reported.

Stephen Stanley, chief economist at Amherst Pierpont Securities, wrote in a note to clients that the Fed's thinking is that if the federal funds rate consistently trades 5 basis points below the interest on excess reserves rate, moving the latter rate lower "will allow the Fed to manipulate the [federal funds rate] closer to the middle of the target range, where it wants it."