In a recent meeting of the financial management officials with bankers in US , it was decided to manage the last minute rush to avoid unwanted price hike.
As the U.S. central bank thinking to raise rates at the end of this year, Simon Potter & his team of market technicians have the tricky job of implementing higher rates using some new and lightly tested tools as well as some that may not work as well as in the past. They’ll be operating under intense global scrutiny that’s centered on the prospects for the world’s biggest economy.
Even as while testing new the methods meant to just sweep up trillions dollars of reserves from financial markets, Potter’s team is preparing for volatility and to make on-the-fly adjustments when the time comes, according to interviews with Fed officials and market participants.
The trouble is that the federal funds market, the intra-bank trading pool traditionally used by the Fed to meet its policy goals, has shrunk to about a quarter of its pre-crisis size after more than six years of unprecedented monetary stimulus.
“There is a lot more uncertainty in the mechanical features of the outlook than people admit to,” said Joseph Abate, a money-market strategist at Barclays Capital.
The Fed wants to avoid a scenario in which yields don’t rise enough after it lifts the fed funds rate because banks, flush with $2.5 trillion of reserves parked at the central bank, don’t need short-term funding.
The central bank also risks being drawn so deeply into money markets that it destabilizes things.
That’s why the New York Fed, already under political pressure due to regulatory missteps, is taking every precaution it can to protect its credibility and that of the central bank. It wants to make sure that when the central bank decrees higher rates, yields will actually rise.
To combat anxieties on Wall Street and in Washington, Potter and his deputies have been hosting regular lunches with market participants to ask and field questions about what sort of market tinkering might be needed or avoided to get it right, and how banks and funds will react.
He has also met with officials at the European Central Bank and other global counterparts to outline the U.S. plan to tighten when most of them are easing.
“The New York Fed is thinking about these things a lot, and so are we,” said Barclays’ Abate, who attended a recent lunch with Potter.
A few blocks off Wall Street, the New York Fed has long handled the central bank’s market operations. This time, it will have to rely on unfamiliar counterparties like money market mutual funds, and new tools such as an overnight reverse repurchase facility, or ON RRP, to vacuum up as many reserves from the system as necessary to achieve “liftoff.”
– THE GLOBAL SPOTLIGHT
The Fed has put on a brave face that it can smoothly lift rates from the current range of zero to 0.25 percent. Fed Chair Janet Yellen told a congressional panel last month that she is confident about maintaining “reasonable control” of short-term yields.
The question is whether the fed funds rate will slip below the “floor” created by ON RRP, likely to be set at 0.25 percent after liftoff. The “ceiling” will be a rate the Fed pays banks on excess reserves, called IOER, likely to be 0.5 percent.
Traders and policymakers alike expect volatility.
Many also expect the fed funds rate to slip toward and even below the floor at the end of quarters and months, when money funds will look to the repo facility to dump cash in exchange for Treasuries, pushing rates lower.
If this slippage happens over and over, the New York Fed is expected to increase its ON RRP program beyond the current overall cap of $300 billion, according to policymakers and traders. It may even make the facility unlimited for a period, and turn to another new tool, term reverse repos, to help drain reserves.
This would be when the central bank risks destabilizing the $2.7-trillion money fund market by encouraging a “disruptive flight-to-quality,” as Fed Vice Chair Stanley Fischer warned this week.
“They’ll do as much as they absolutely have to, and they may get there through trial and error,” said Louis Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. “Managing the communications at the top level will be critical because there is simply no precedent for this liftoff.”
In past several months, Potter & his top aide Lorie Logan and The Joshua Frost have been inviting a group of traders and bankers at a time to lunches at the New York Fed.
Potter, who co-headed the New York Fed’s research wing before taking over its market operations in 2012, uses the meetings to ask how best to avoid fed funds slippage, sources said. He’s also asked whether aggressive use of term repos would disrupt usage of ON RRP.
Potter will address the Money Marketeers bond traders group on April 15, a speech that quickly sold out.
He and others in New York Fed’s market operations unit declined interview requests.
Logan and Frost are veterans of the markets group who, unlike Potter, were there in the depths of the 2008 financial crisis when U.S. rates were last adjusted. Several others in the group have since left, leaving some new faces to begin raising rates.