As the Federal Reserve System sits on an Interest rate on Reserve Balances (IORB) of 5.4% that they set by dictate each time they meet for “monetary policy” decisions, the 3-month Treasury bill rate continues to follow it nearly identically. This is true even though the IORB is the rate the Fed began paying in 2008 for all reserves held at the Fed, which was first called the Interest on Excess Reserves (IOER). It became instead the “IORB” once the Fed dropped reserve requirements in 2020, since excess reserves had swooned to $4 trillion. All, despite the fact that the original 2006 Financial Services Regulatory Relief Act was passed to allow the Fed to pay interest to private banks only for the required reserves held at the Fed, not all reserves. (The idea was to level the playing field between small and large banks, since small banks had more reserves per deposits than large banks. Now large banks dominate the receipt of IORB payments).
Since the 3-month T-bill follows the IORB, let’s just use the IORB and see what the real interest rates are. The real rate is the residual of the market rate minus the inflation rate: what you get in interest after inflation when you lend capital.
The IORB rose above the inflation rate for the first time since Trump was President in April 2023 and has stayed above continually now for over a year. For this period from April 2023 to May 2024, the IORB averaged 5.31%, the inflation rate averaged 3.49%, and the real interest rate was by this measure 1.82%. This is after having a negative real T-bill interest rate for nearly every month from 2001 to 2023; there were about 3 years of positive real T-bill interest rates in these 22 years and 19 of negative real interest rates.
For the last 12 months, the IORB has averaged 5.36% and the inflation rate 3.32%, giving an average positive real interest rate of 2.04%, again after nearly 20 years of negative real interest rates.
The Fed’s abrupt change in policy rates, from driving the real rate negative for two decades to imposing a 2% real rate for the last year, can hugely distort markets. Now we see this Nowhere Man Fed policy driving the real estate market into distress. We finally have a run on real estate holdings after Starwood Capital Group capped withdrawals from its fund. Real estate investment trusts (REITS) as an industry whole face an amount of withdrawals that dwarf the amount of new deposits. This is how a run takes place in markets.
The Fed insists inflation is not low enough to cut rates, when all that matters is what the real interest rate is since this determines the cost of capital. Sitting in their Nowhere Land in Washington D.C., the markets are beginning to implode in the Everywhere Land of global capital markets.
Max Gillman 