Fed Quizzed Primary Dealers About New Tool to Manage Rates

(Bloomberg) -- The Federal Reserve Bank of New York has quizzed some primary dealers about a potential new tool for managing interest rates as the central bank prepares to halt its balance-sheet unwind, according to people familiar with the discussions.

The New York Fed's markets group has sought feedback on how an instrument that keeps money-market rates from rising too far above the central bank's target range should be designed, and how it would impact markets. That's according to three people who attended meetings on the issue, who asked not to be identified because they're not authorized to discuss them. Primary dealers are firms that transact directly with the Federal Reserve in its implementation of monetary policy.

It's the New York Fed's responsibility to implement the Federal Open Market Committee's monetary policy decisions in financial markets and in doing so it regularly speaks with market participants about a range of issues to understand what they're thinking, according to a New York Fed spokesperson.

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The conversations are part of ongoing preparations for a probable end later this year to the Fed's rolloff of bond holdings. The process will complete the gradual shrinking of its balance sheet, which ballooned to $4.5 trillion in the aftermath of the crisis as the Fed bought assets to lower borrowing costs. It now stands close to $4 trillion.

Minutes of December's policy meeting indicated that some officials expressed an interest in learning more about possible options for new ceiling tools to provide firmer control of the policy rate. An account of January's meeting mentioned a year-end spike in rates for repurchase agreements, which occurred during a reduction in overnight lending as market participants shored up balance sheets for regulatory purposes. This saw the highest repo rates since 2001.

The Fed's benchmark rate is currently managed in a target range of 2.25 percent and 2.5 percent. To manage rates, the Fed pays interest on excess reserves, currently set at 2.4 percent, and on reverse repurchase agreements, currently set at 2.25 percent.

One possibility for providing a ceiling could be a standing Fed facility at which it would offer funds.

The Fed markets group also inquired as to where the rate should be set relative to the interest on excess reserves rate, two of the people familiar said. They also asked about how frequently the operations should be conducted, whether daily or only at quarter-end and year-end, the people familiar said.

While the New York Fed does poll dealers on broad issues surrounding markets and monetary policy, the questions related to a possible new tool were more specific than usual, two of the people familiar said.

To contact the reporters on this story: Alexandra Harris in New York at aharris48@bloomberg.net;Matthew Boesler in New York at mboesler1@bloomberg.net

To contact the editors responsible for this story: Alister Bull at abull7@bloomberg.net;Benjamin Purvis at bpurvis@bloomberg.net

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