Logan: Fed's Tools Allow for Further Quantitative Tightening

Lorie Logan, President of the Federal Reserve Bank of Dallas, suggested that money markets could face some temporary pressure around the end of next quarter, particularly with the September tax date looming. However, she emphasized that the Federal Reserve still has room to continue shrinking its balance sheet, thanks to available tools like repurchase agreements and the discount window.

Speaking at a conference hosted by the Bank of Mexico, Logan explained that these tools act as “valves” that can help alleviate any potential strains in the money market.

Reverse Repo Facility and its Impact

The reverse repo facility is an important tool designed to prevent liquidity shortages, allowing eligible institutions to quickly convert their holdings of U.S. Treasury securities into cash. This, in turn, reduces the need for direct intervention by the Federal Reserve.

Typically, this facility remains unused, but it has been utilized during periods of declining bank reserves, as seen at the end of September 2004. Investors again turned to it last June.

Balance Sheet Reduction: The Fed's Goal

Since 2022, the Federal Reserve has aimed to reduce its balance sheet, with the goal of returning bank reserves to a “minimum abundant level” to avoid market disruptions. This action follows the purchase of trillions of dollars in assets to stimulate the economy after the COVID-19 pandemic.

Although the Fed has slowed the pace of quantitative tightening this year, officials are still discussing how far they are from reaching the final level. According to the latest data, bank reserves stand at approximately $3.3 trillion. Fed Governor Christopher Waller estimates that the minimum abundant level is around $2.7 trillion.

Repo Market Rates and Discount Window

Logan mentioned that the average rate in the repurchase agreement market has been about 8 basis points lower than the interest the Fed pays on bank reserves. This indicates that there is room to reduce reserves.

In addition, the Fed provides liquidity to banks through the discount window. Logan called for considering increasing or removing restrictions on the size of discount window loans, or conducting central clearing for these transactions. She also reiterated her previous suggestion that the Fed should auction off discount window loans daily to facilitate the distribution of liquidity within the banking system.

Logan as a Potential Fed Chair Candidate

Logan is considered a potential candidate to replace Jerome Powell as Chairman of the Federal Reserve after May 2025. In her speech, she avoided commenting on monetary policy or economic forecasts, but she noted last month that a weakening job market “might” require interest rate cuts “soon.”

Answering questions after her speech, Logan expressed satisfaction with the policy framework assessment recently completed by the Federal Reserve. However, she noted that there is room for improvement in the way the Fed communicates, such as adjusting the quarterly Summary of Economic Projections (SEP).

In summary, Logan focuses on managing liquidity cautiously, emphasizing the importance of the tools available to the Federal Reserve to maintain market stability and gradually reduce the balance sheet without causing disruptions. Understanding the nuances of these tools is crucial for interpreting the Fed's future actions.