It has been fascinating to watch market attention shift following the conclusion of the Fed’s Quantitative Tightening (QT) program on December 1st.

The focus appears to have now shifted to the Fed’s upcoming purchase of T-Bills to manage liquidity.

Ah, and that still leaves the Interest on Reserve Balances (IORB) as the elephant in the room.

To me the IORB remains a structural anomaly; something that has quietly created a regulatory arbitrage for the largest banks, particularly since rate tightening began in March 2022.

The largest U.S. banks earn the IORB rate (currently approx 3.90%) on the reserves they park at the Fed.

In a parallel world, they pay the average retail saver a fraction of that on standard savings accounts (~ 0.4%)

This spread represents a vast, risk-free profit margin – a guarantee from the Fed on funds that they [the Commercial Banks] have acquired at the cheapest possible rate.

You could slice it and dice this anyway.

This is, by any definition, an ANOMALY.

It deserves far more scrutiny than it receives currently.

But first, the backstory: why did the IORB come into existence?

While politically charged (with Congress periodically seeking to abolish it), the IORB is possibly here to stay because it is the lynchpin of modern monetary policy.

The IORB’s primary function is to provide a floor for interest rates, effectively replacing the pre-2008 Inter-Bank Lending Market.

It eliminates the need for banks to lend to one another (which could and had indeed led to the notorious credit freeze of 2008), incentivizing them to park reserves with the Fed for a risk-free return, thereby guaranteeing the Fed’s control over the short-term rate.

And despite the congressional pressure on the Fed to eliminate the IORB (and go back to the zero-interest-paid-on reserves era prior to the GFC), it [IORB] is likely to remain because who would really want to take a chance with bank credit risk again?

So, what does a saver really do in a situation like this?

Well, since a savings account holder cannot open an account at the Fed to get the IORB rate, the smartest move then for cash management is to exploit the very market dynamics the Fed created:

Instead of leaving cash in low-yield savings accounts, the most rational approach is to invest them into Money Market Funds (MMFs) instead.

MMFs, in turn, invest in high-quality short-term assets (T-Bills, Treasuries, and highly liquid securities) or execute Overnight Reverse Repurchase Agreements (ON RRP) directly with the Fed.

This then allows a saver to bypass the bank’s low-paying deposit window and earn a rate much closer to the Fed Rate.

The anomaly still remains.

But this is your best bet at making the most of it.