J.P. Morgan, Morgan Stanley see U.S. Fed may cut interest on reserves next week

NEW YORK (Reuters) - The Federal Reserve may lower the interest it pays on excess reserves banks leave with it by 5 basis points at its April 30-May 1 policy meeting in a bid to prevent the federal funds rate from drifting higher, two primary dealers said on Friday.

The fed funds rate has been running consistently above the interest on excess reserves (IOER) since mid-March, fanning worries excess bank reserves are scarce, which would drive up short-term borrowing costs broadly.

On Thursday, the average or effective fed funds rate (EFFR) stood at 2.44%, 4 basis points above the current IOER level.

"We believe the move higher in EFFR comes as a surprise to the Fed and most market participants since there has been a belief that at current reserve levels EFFR is likely to remain sticky close to IOER," Morgan Stanley strategists Matthew Hornbach and Sam Elprince wrote in a research note.

If the Fed reduces the IOER spread to the lower end of its target range on interest rates, it would mark the third such "technical" adjustment on the interest on excess reserves (IOER) following cuts last June and December.

"If the funds rate continues to trade near recent levels, we think there's about one-in-three chance they make another 5 (basis points) technical adjustment to the IOER rate," J.P. Morgan economist Michael Feroli wrote in a note.

J.P. Morgan and Morgan Stanley are among 23 Wall Street firms that do business directly with the Fed.

For a graphic on U.S. federal funds activity, click: https://tmsnrt.rs/2EcJkRq

(Reporting by Richard Leong; Editing by Chizu Nomiyama and Bill Trott)