Thursday, February 11, 2010

Gearing up for Reserve Drains...

Utilizing Money Market funds. The problem is exchanging reserve balances for reverse-repo actions produces very little net effect outside of a change in the bank's liquidity profile. (from daily liquidity to 2+ days liquidity). This article misplaces what actions the Fed takes when executing interest rate policy.

Feb. 11 (Bloomberg) -- The Federal Reserve is in talks with money-market mutual funds on agreements to help drain as much as $1 trillion from the financial system as policy makers prepare for the first interest-rate increase since June 2006, according to a person familiar with the discussions.

The central bank is looking to the $3.2 trillion money- market mutual-fund industry because the 18 so-called primary dealers that trade directly with the Fed have a capacity limited to about $100 billion, estimates Joseph Abate, a money-market strategist at Barclays Capital in New York...

The central bank has created more than $1 trillion in excess reserves in the banking system through its purchases of $300 billion of Treasury debt and $1.25 trillion of mortgage- backed securities. To put upward pressure on the federal funds rate, the Fed may need to drain as much as $800 billion, Abate estimates.

One potential tightening tool is the interest rate on reserves that commercial banks keep on deposit at the Fed. By raising that rate, the central bank “will be able to put significant upward pressure on all short-term interest rates,” Bernanke said.

The Fed can also use reverse repos to shrink the quantity of reserves, which in turn gives it “tighter control over short-term interest rates,” he said.

No comments: