reverse repos

Perhaps to offset rumours of further easing, the Fed has announced further trial runs of a key tightening tool.

The New York Fed will test one of its main liquidity-draining tools by conducting a “series of small-scale, real-value reverse repurchase transactions” with primary dealers et al. This repeats and expands upon a similar set of tests announced in October and run in December

Simone Baribeau

Baby steps.

The Federal Reserve today moved one – itty bitty – step closer to getting reverse repos ready to drain the system of excess reserves. Not that they’re in much of a hurry – monetary tightening still seems to be a long way off in the distance, but nice to be prepared. 

Simone Baribeau

The Federal Reserve Bank of New York said today that it would expand its counterparties for conducting reverse repurchase agreement transactions.

“This expansion is intended to enhance the capacity of such operations to drain reserves beyond what could likely be conducted through the New York Fed’s traditional counterparties,” the NY Fed said in a statement.

The NY Fed has been testing “reverse repos” since last December in preparation for eventual monetary policy tightening and as early as last October had announced that it would expand its counterparties for these transactions.

Reverse repos are one of the tools the Fed has said it plans to use to drain excess reserves from the financial system once it begins its exit strategy in earnest. But Ben Bernanke, Fed chairman, has made clear that he does not expect it to be the primary tool – rather, the Mr Bernanke intends to use the interest rate the Fed is paying on its holding of bank reserves to be the “most important” technique for draining the funds. 

Krishna Guha

If the Fed is bothered about primary dealers lacking the balance sheet capacity to do reverse repos on a large scale, why not use its regulatory powers to ease these constraints? The Fed might want to do as much as $500bn in reverse repos. The dealers have balance sheet space for $100bn at most.

A short-term reverse repo with the central bank ought not to be the kind of asset a bank needs to set much capital aside for, nor the kind of asset that counts against crude leverage limits. I am not an expert on the regulatory side of this but I suspect the Fed might be able to do something about this if it put its mind to it. 

Krishna Guha

The Fed would like to mop up a decent share of its excess reserves to reduce the pressure on the paid interest facility and it’s eying the money-market mutual fund industry to help, writes Krishna Guha of the Financial Times