NY Fed: Testing Exit Tool, Not Using It Yet
Published: Monday, 19 Oct 2009 | 11:19 PM ET By: Reuters The Federal Reserve Bank of New York said on Monday that it is testing one of its tools for withdrawing cash from the banking system, but stressed this should not be taken to mean that it is about to use it. The Federal Reserve -- the U.S. central bank -- has said that so-called "reverse repos" could be one way to drain excess reserves when the time comes to reverse the massive cash injections it has made into the banking system. "This work is a matter of prudent advance planning by the Federal Reserve, and no inference should be drawn about the timing of monetary policy tightening," the New York Fed -- the U.S. central bank's operational arm -- said in a statement. The debate over when the Fed should rein in its support is growing louder. U.S. policy-makers have stressed that now is not the time to tighten monetary policy, but there have been differences about what rules of thumb to use to determine how soon the first rate hike should come. The Fed cut its benchmark interest rate to near zero percent in December and pumped hundreds of billions of dollars into the financial system as it combated the financial crisis. It will eventually need to withdraw that support, or risk inflation. The influential weekly magazine Barron's chimed in this week with a picture of Fed Chairman Ben Bernanke on its cover and a headline that read: "It's time to raise rates, Ben." Recent news reports that the Fed was testing reverse repos had been fanning speculation that the central bank is about to drain liquidity by selling assets such as Treasuries to dealers for cash with an agreement to buy them back later at a higher price. The New York Fed's announcement sent U.S. Treasuries briefly higher. The New York Fed said it has been working over the past year to ensure that "this tool will be ready when and if" the policy-setting Federal Open Market Committee (FOMC) decides to use it. It said the tests were of their systems and that no reserves have changed hands. It said there will be more tests. "Communications around the exit strategy remain a challenge for the Fed. While the FOMC would like the reassurance of knowing that new reserve management tools will work as planned, testing those tools risks leading the market to believe that rate hikes are imminent," said Michael Feroli, U.S. economist at JPMorgan. "Today's statement by the NY Fed was a first effort to distinguish tests of exit strategies from the commencement of the exit," he wrote in a note to clients. Tri-Party Planning Repos and reverse repos have been in the Fed's toolkit for years and both were used as recently as December 2008. The focus of the Fed's recent discussions and tests was to get the documentation and systems in place to be able to conduct so-called tri-party reverse repos, the New York Fed said. In the tri-party repo market, clearing banks JPMorgan Chase & Co and Bank of New York act as intermediaries, which allows for a wider range of instruments to be used in a transaction. The Fed has been conducting tri-party repos -- though not tri-party reverse repos -- with primary dealers since 1999. Bernanke said in July that the central bank could conduct reverse repos with other institutions aside from the network of primary dealers, its usual trading partners. Some analysts have said the primary dealers on their own would not be able to conduct reverse repurchase operations of the scale likely to be needed. Analysts say the Fed could conduct reverse repos with money market funds, for example. The Fed has more than doubled its balance sheet -- its credit to the banking system -- to more than $2 trillion to battle the crisis. The New York Fed said the central bank is "continuing to study this issue, and no decisions have been made regarding the types of firms that may be included." The New York Fed will "engage market participants on this subject as appropriate going forward," it said. __________________________________________________ Do You Yahoo!? Tired of spam? Yahoo! Mail has the best spam protection around http://mail.yahoo.com
