New Policy Tools? The Fed Has Wandered Down This Road Before

(Bloomberg) -- When it comes to the Federal Reserve’s discussions about new tools to control short-term interest rates, the central bank has been here before.

Transcripts from the Fed’s 2013 meetings released Friday included an unscheduled gathering in October as the Treasury wrangled with the looming debt-ceiling deadline. On the conference call, officials discussed intervening in the market for Treasury repurchase agreements should funding rates show signs of strain. The conversation ultimately veered toward a broader discussion about incorporating a Treasury repo facility into the Fed’s monetary framework if volatility in the repo market persisted. St. Louis Fed President James Bullard said the central bank “should consider this as part of our toolkit.”

Now, minutes from the Fed’s Dec. 18-19 meeting released last week show some participants expressing an interest in learning more about possible options for new tools to provide firmer control of the fed funds rate. The benchmark has been drifting toward the upper end of the central bank’s target range for much of the past year. Year-end volatility in repo rates and potential swings in funding markets related to the Fed’s balance-sheet unwind and another approaching debt-ceiling showdown further underscore the importance of the central bank’s role in controlling money-market rates.

Underlying general collateral “pressures are most likely going to be resolved by the Fed backstopping the repo market,” Bank of America strategists Mark Cabana and Olivia Lima said in a note published Jan. 11.

Here are other issues policy makers discussed in 2013 to ameliorate the threat of a default due to the debt ceiling:

  • Real risk of failed auctions surrounding the drop-dead date; In a recent bill auction, two dealers bid for less than their market share, then-New York Fed President William Dudley said, and “if two dealers wouldn’t show up to their pro rata share, there’s always a risk more wouldn’t. And they could potentially have a failed auction.”
  • Staff laid out five possible actions the Fed could do: Outright purchases, securities lending, rollovers, repos to keep the fed funds rate in its target range and discount window lending
  • Other actions discussed revolved around possible strains in money markets: Conducting reverse repo operations using “unblemished” Treasury collateral and CUSIP swaps

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