Primer: Fed policy plumbing, ’26 edition

Research evidence excerpt

Primer: Fed policy plumbing, ’26 edition

• IORB: the Fed’s primary tool for controlling money markets since it serves as a rate

at which banks will be hesitant to lend below. Depository institutions receive this

rate on reserves held at the Fed.

• ON RRP: intended to function as a floor for money market rates. ON RRP allows the

Fed to drain cash out of the banking system when money market rates are too low.

• SRP: intended to act as a ceiling for UST secured funding. The SRP allows the Fed

to add cash into the banking system when reserves are limited in relation to the

amount of UST collateral outstanding. Although the SRP was only formalized in ’21,

the Fed has been operating a functional SRP / daily repo operation since ’19.

Detail on Fed policy target, key rates, & primary tools

EFFR (effective Federal Funds Rate)

The EFFR is the primary monetary policy target for the Fed. According to the NY Fed,

the EFFR “consists of domestic unsecured borrowings in U.S. dollars by depository

institutions from other depository institutions and certain other entities, primarily GSEs.”

The EFFR is calculated as a volume-weighted median of overnight FF trades.

Daily volumes in the overnight EFFR market rose leading into and peaked at $144b

around the March ’2023 bank stress events but have since declined to an average of

$102b YTD (Exhibit 2). Today, we believe roughly 90-100% of all FF activity is driven by

government sponsored enterprise (GSE), primarily FHLBs, lending to foreign banks

(discussed further below in the Dynamics of the Fed funds market section).

OBFR (overnight bank funding rate)

The Fed publishes another broad overnight unsecured bank borrowing rate along with

EFFR: the overnight bank funding rate (OBFR). This rate is not the Fed’s policy target but