The US Federal Reserve is taking an additional measure to lay the groundwork for draining excess reserves from the banking system, as it seeks to remove some of the $1 trillion in cash it injected during the global credit crisis.
The New York Federal Reserve, which conducts open market operations for the US central bank, said on Monday it has begun a programme to expand the number of firms conducting reverse repurchase agreements, or "reverse repos", including domestic money market mutual funds.
Analysts anticipate housing agencies Fannie Mae and Freddie Mac will be the next group added to the New York Fed's list of reverse repo counterparties. Fed Chairman Ben Bernanke has recently spoken of them as possible candidates for reverse repos.
The New York Fed said the announcement should not be read as a signal for changes or timing in overall monetary policy.
Reverse repos are one of the key tools that the US central bank has said it will use to drain excess reserves from the banking system to help prevent inflation as the US economy recovers.
In a reverse repo the New York Fed sells securities to certain financial firms for later repurchase. Traditionally, it transacts the operations with "primary dealers" on Wall Street, or those financial firms that are permitted to trade government securities directly the the Federal Reserve.
However, due to the unprecedented amount of excess reserves, the New York Fed has signaled it will expand the types of firms it would do this business with. "This expansion of counterparties for the reverse repo programme is a matter of prudent advance planning," the New York Fed said in a statement.
The New York Fed has not conducted reverse repos this year, though it did conduct small scale reverse repo tests late last year with primary dealers.
There was little market reaction to the Fed announcement on Monday. The average overnight interest rate on federal funds, or lending of excess reserves between banks, was last bid at 0.1600 percent on Monday, unchanged from late Friday.
CRITERIA FOR NEW PLAYERS
The New York Fed said its reverse repo program will be aimed at firms including domestic money market mutual funds that provide large amounts of short-term funding to financial markets.
"Basically the Fed needs a bigger pool from which to draw in order to conduct these reverse repos," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco
The New York Fed requires firms have net assets of no less than $20 billion for six consecutive months prior to applying as a reverse repo counterparty. It said it expects to publish a "master" repo agreement for money market funds in about a month.
The agreement will spell out the legal terms and conditions for money market funds as New York Fed's counterparties, according to analysts.
The additional counterparties for its reverse repos programme will not be eligible to participate in other transactions conducted by the New York Fed.
PAVING THE WAY
By including money market funds, the New York Fed could remove another $200 billion in reserves, said Joseph Abate, money market strategist with Barclays Capital in New York.
This is top of an estimated $100 billion in reverse repos with primary dealers and the Treasury Department's planned $200 billion in bill issuance from its Supplementary Financing Programme, he said.
If the New York Fed were to add Fannie Mae and Freddie Mac as counterparties, its capacity to drain reserves would increase further, Abate said. It was not clear how much cash the government sponsored mortgage agencies have to participate in reverse repos with the Fed.
Freddie Mac declined to comment on the matter and Fannie Mae was not immediately available to comment. Whenever the New York Fed begins to conduct reverse repos, the overnight repo rate -- the cost that Wall Street firms can borrow in the open market using Treasuries as collateral -- could rise to near 0.25 percentage points, the top of the Fed's target range on short-term rates.
Longer-term repo rates, may trade 0.05 percentage point to 0.10 percentage point above the overnight rate, Abate said.
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