MNI INTERVIEW: Fed's Best Repo Fix is More Reserves: McAndrews

--Still potential for year-end strain and rates to spike

By Evan Ryser

     WASHINGTON (MNI) - The Federal Reserve seems to be moving in the right

direction on tackling repo market volatility but nobody knows if year-end

liquidity is sufficient, former New York Fed research chief James McAndrews told

MNI.

     Policymakers should stick to keeping enough reserves in the existing system

and avoid structural changes to the Treasury General Account or foreign repo

pool, he said in an interview.

     "The solution for this is very simple. It's not as though you need

mysterious facilities and new ways of doing things. The solution is to provide

enough reserves," McAndrews said. "By simply adding reserves they will come into

more or less a rough balance with demand for reserves that have now been

revealed."

     Referring to year-end repo concerns, McAndrews said, "the Fed is certainly

moving in the right direction, and whether it will be sufficient or not I don't

think anyone knows."

     The Fed is reviewing the factors that caused short-term interest rates to

spike in September, and Treasury Secretary Steven Mnuchin has said the agency is

focused on the issue and year-end funding concerns. Strains in overnight markets

triggered the Fed to inject billions into money markets for the first time since

the financial crisis and to buy T-bills to build reserves. 

     The Fed's balance sheet has grown to $4.1 trillion from $3.8 trillion in

September.

     The needed buffer to avoid the steeper part of the demand curve can be

ambiguous and demand may still go beyond the buffer to bring a spike in interest

rates, McAndrews said. "That's an easy sort of mistake to make. I'm quite

sympathetic with the Fed here."

     The Fed has been vexed by unanticipated growth and fluctuations in the

Treasury General Account and the foreign repo pool, part of its non-reserve

liabilities. The two combined totaled $629 billion on Thursday, more than the

$300 billion in bills the Fed plans on purchasing.

     Some have therefore suggested the Treasury needs to return to keeping cash

in the private sector using Treasury Tax and Loan accounts, and the Fed needs to

reimpose constraints on the foreign repo pool to help control variability in

reserves.

     "It is a false economy to say the least," McAndrews said. "As the Fed has

said itself, these balances convey social benefits. They don't say what the

social benefits are, but basically the social benefits are convenience," said

McAndrews, who retired from the New York Fed in 2016 after 28 years in the

Federal Reserve system.

     -- FOREIGN REPO POOL

     The foreign repo pool may be volatile, McAndrews said, but he hopes the Fed

does not put a cap on it.

     A decades-old New York Fed program, the foreign repo pool allows foreign

central banks and multilateral agencies like the Bank for International

Settlements to deposit money at the Fed and earn interest.

     The program has grown from an average level of around $30 billion before

the financial crisis to $251 billion now. It has shrunk by $56 billion since its

reported high of $306 billion on September 18, with some analysts suggesting

that slide may reflect recent changes in the terms of the program.

     -- TREASURY GENERAL ACCOUNT

     Officials years ago moved away from Treasury Tax and Loan accounts, TT&L,

where the Fed did business with hundreds of banks to the Treasury General

Account, adding uncertainty to the banking system's supply of reserves.

     But Treasury's General Account grew by $120 billion in a month around

September. "That is volatility. So that's a structural change, and the solution

for that is very simple," McAndrews said. "The solution is to provide enough

reserves."

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

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