Wall Street strategists are divided on which interest rate should replace the federal funds rate if the Federal Reserve decides to abandon it as a policy target.

Dallas Federal Reserve Bank President Lorie Logan suggested last week replacing the federal funds rate with the more commonly used Tri-party General Collateral Rate (TGCR), which is linked to the repo market. Analysts have long complained that the Fed's current benchmark rate no longer reflects how monetary policy transmits to the broader economy.

While strategists generally agree that Logan's comments may represent the first step toward eventually replacing the federal funds rate, they disagree on which alternative rate to choose. Analysts at Wrightson ICAP, Wells Fargo, and RBC Capital Markets believe TGCR is the preferred alternative because it is directly affected by Fed operating rates, such as the standing repo facility and reverse repo facility rates.

However, analysts at Bank of America and Citigroup favor the Secured Overnight Financing Rate (SOFR), arguing that it already has a mature derivatives market and reflects all funding conditions, including leveraged borrowers.

The federal funds market has shrunk dramatically after massive monetary stimulus during the financial crisis and pandemic led to excess liquidity in the U.S. banking system, with most funds parked at the Fed. This has virtually eliminated banks' need to borrow from each other to maintain minimum reserve requirements.

Over the past 15 years, federal funds market trading has been replaced by repo activity—overnight loans collateralized by Treasury securities. This market is open to more types of financial participants, offers more attractive rates, and could potentially improve monetary policy effectiveness.

**Strategist Views:**

**Wrightson ICAP (Lou Crandall, September 29 report)** If the Fed chooses to adopt a single rate as its new operating target, TGCR is the strongest candidate. The spread between SOFR and TGCR can reflect regulatory costs and balance sheet costs for dealers, which the central bank cannot address.

"If market conditions and/or Federal Home Loan Banks' liquidity management behavior further weaken the connection between the effective federal funds rate and overnight repo rates that actually matter to the economy, the Fed may have to reorganize its operating framework in a short time," Crandall wrote. "It needs to have a backup plan."

**Wells Fargo (Mike Schumacher, Angelo Manolatos, September 26 report)** TGCR better represents the marginal cost and return on investment in short-term funding markets. The shrinking volume in the federal funds market and lack of sensitivity to overall market conditions "are very compelling reasons for changing targets."

The Fed will likely continue to enhance the effectiveness of the standing repo facility through measures such as centralized clearing. The strategists also believe that even if the Fed targets TGCR, it may still make operating rate adjustments—including changes to the standing repo facility—to keep the benchmark within range.

"In an environment where TGCR is the target rate, we suspect the Fed would moderately tolerate small, brief breaches above the target range ceiling at quarter-ends."

**Goldman Sachs (William Marshall, September 26 report)** A shift in policy targets toward secured funding metrics could lead to "reduced tolerance for spikes in secured funding costs." Making TGCR the official target would reinforce the Fed's commitment to ensuring rates stay within range.

Any changes would likely require time and further discussion to take shape, though there's potential for near-term adjustments to better test the Fed's existing tools.

The Fed clearly needs robust contingency planning for the possibility of shifting to a new operating target. "However, we prefer to wait for greater clarity before making final decisions on specific details," but last week's speech "largely reminded markets of potential future changes."

**JPMorgan Chase (Teresa Ho et al., September 26 report)** Before deciding to make TGCR the new policy target, officials must consider how to ensure the benchmark stays within the target range.

This means strengthening the standing repo facility and ensuring it becomes an effective tool for controlling and limiting repo rates, just as the overnight reverse repo facility provides a floor for money market rates.

**Citigroup (Jason Williams, September 26 report)** Williams noted that the Fed may have greater direct control over TGCR than over SOFR. However, targeting TGCR "would mean the Fed controls the rate that cash borrowers receive from U.S. Treasury repos, while SOFR also includes intermediation costs."

There are also reasons to target SOFR, mainly because policymakers supported SOFR as the new benchmark in the post-Libor era. "Would they want to encourage building a new derivatives market around TGCR?"

The Fed wouldn't want a situation where TGCR stays within the target range while SOFR prices outside it, as this would indicate "substantial monetary policy transmission problems," Williams said. "In other words, if cash borrowers are paying premiums well above the Fed's newly set tri-party rate target for ultra-safe U.S. Treasury collateral, the real economy might pay even higher premiums."

**Bank of America (Mark Cabana, Katie Craig, September 26 report)** A Fed policy target shift from the federal funds rate to a repo-based benchmark could take a year to implement.

As part of any initial transition, the Fed might target a broader set of money market rates, such as both federal funds and repo rates. Since numerous financial contracts reference the federal funds rate, the Fed would likely continue publishing this rate.

The strategists advocate replacing the federal funds rate with SOFR. "Either repo rate would be vastly superior to the federal funds rate," they said.