MNI INTERVIEW: Fed Likely To Set Stable Rate for Repo Facility

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve is likely to set its proposed

standing repo facility at a fixed spread to its policy target range, and would

prefer not to make periodic adjustments to the new rate, Philadelphia Fed

economist Roc Armenter said in an interview.

     The Fed is mulling creating the new facility, which would lend out cash

against bonds provided as collateral, in order to reduce the pressure on banks

to hold high levels of reserves by providing reassurance that they can be raised

immediately if necessary. That would make it easier for the central bank to

restrain unusual spikes or sustained upward pressure on the fed funds rate.

     "The facility can serve several purposes, but No. 1 will be to ensure

interest rate control in the fed funds market. That said, how you design that

facility to meet just that goal is not straightforward at all," Armenter said,

referring to questions over where to set the offering rate and deciding who is

allowed to tap the repo loans.

     The repo facility rate would seek to strike a balance between securing

firmer control over money market rates and the danger of crowding out private

entities.

     "Be very aggressive with interest rate control at the risk of inviting a

lot of disintermediation. Or be a little bit more loose with interest rate

control and keep the usage not that high on a daily basis," Armenter said,

outlining the extremes between which the Fed will seek to steer.

     In contrast to the recent management of the interest rate on excess

reserves, the Fed's primary tool for controlling the fed funds rate, the

standing repo rate is unlikely to see periodic adjustments.

     "There will be a preference for a fixed, predictable rate that moves with

the target range. if there's no need to move things around, let's not move it

around," he said.

     The FOMC was forced to lower IOER by a cumulative 15 bps over the past year

to keep the effective fed funds rate trading near the midpoint of its target

range. A shrinking balance sheet, increasing Treasury issuance, as well as

higher sensitivity to repo rates in recent months had boosted the fed funds rate

alongside short-term money market rates.

     "Technical adjustments to IOER have worked very well, and the fed funds

rate is well within the target range, but we always have to be worried about

what's going to happen in the future as reserves decline and repo rates head

upward."

     --ACCESS TO FACILITY

     Allowing primary dealers, who are active in repo markets, to access

standing repos could result in very sizeable daily operations, and mean that the

facility's effect on fed funds rate control would be only an indirect one,

Armenter noted.

     The repo market, having nearly doubled in size in the past year to $1.2

trillion in daily volume, dwarfs the $60 billion in fed funds trading volumes.

     "If the facility is opened up to institutions active in the repo market,

we'll expect interest rate control to manifest first in the repo market. These

days there is a lot of pass-through from repo to fed funds, but that will be

somewhat indirect," he said.

     "On the other hand, if institutions that are active in the fed funds market

have access to the facility, you get a straight ceiling on the fed funds market,

a much more direct effect," but that set-up would be very similar to the highly

stigmatized discount window, he said.

     Other concerns include creating a level playing field for counterparties of

all sizes to have access to funding on the same terms and legal restrictions on

how the New York Fed defines counterparties, Armenter said.

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

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