MNI INTERVIEW: Ex-Fed McAndrews Sees Possible Reserves Squeeze

By Evan Ryser

     WASHINGTON (MNI) - A surge in U.S. Treasury borrowing could drain bank

liquidity, making control of short-term interest rates more difficult for the

Federal Reserve and an expansion of its balance sheet more likely, James

McAndrews, former head of research at the Federal Reserve Bank of New York, told

MNI.

     Following a deal to extend its debt ceiling, the Treasury expects to borrow

$433 billion in the third quarter, $274 billion more than it estimated in April,

and up from $381 billion in the fourth quarter.

     "If the Treasury quickly issues hundreds of billions of additional bills,

then we might see signs of reserve stringency," McAndrews, who retired from the

New York Fed in 2016 after 28 years in the Federal Reserve system, said in an

interview.

     "I think the Fed may come to be a bit low on reserves," he said, adding

that a rush of bill sales could prompt a squeeze on short-term rates. "There is

the potential for some dissonance in the Treasury's policy if it issues a lot of

bills and the Federal Reserve's policy of hoping to keep a lid on short-term

rates."

     Tools available to the Fed for keeping its target federal funds rate within

its preferred band between 2.0% and 2.25% include lowering the interest on

excess reserves rate or undertaking temporary repo operations. But McAndrews

said that if the Fed goes ahead with its mooted introduction of a standing repo

facility, it could also use that to expand its balance sheet, easing the

pressure at the short end of the curve.

     But any Fed response to a liquidity drain would be for "maintaining a

condition in the market of ample reserves," McAndrews said, adding that

aggressive credit easing moves such as a return to quantitative easing were

unlikely.

     "I would be surprised to see if the Fed has any plans to expand its balance

sheet immediately."

     The U.S. economy has been "performing quite well," McAndrews said.

     While growth and hiring have slowed somewhat, "those two signals by

themselves are not necessarily problematic," he said.

     "However, the financial markets, and again I am thinking of the inverted

yield curve, are suggesting that investment demand is much more limited than one

would hope and that the future growth is maybe affected as a result. So that is

more troublesome."

     While the precise level of reserves which would trigger a Fed response is

unclear, liquidity concerns might be more acute at the ends of months and

quarters, as banks move to comply with regulatory requirements and put their

books in order for reporting purposes.

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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