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When it comes to determining the best long-term fix for the U.S. funding market and maintaining control over its benchmark interest rate, the Federal Reserve is trying to decide between the lesser of two evils.
At the Oct. 29-30 Federal Open Market Committee meeting, staff presented two potential approaches for repurchase-agreement operations, minutes from the gathering released Wednesday showed.
One -- the frequent repo offerings it’s been conducting since mid-September -- was viewed as posing little risk of stigma or moral hazard. But it was seen as making it more difficult to control the effective fed funds rate given the unpredictability of demand. The other, a standing repo facility -- which some strategists and Fed officials have called for -- could provide “substantial control” over the central bank’s target benchmark. But the concern was that it could become stigmatized if the rate were set too high or possibly be overused if the rate was too low.
“There’s no clear line between the two options and you have to pick between one and the other,” said NatWest Markets strategist Blake Gwinn. “It’s still not entirely clear that there are distinct options.”
Gwinn also said there’s a third option, which is where the Fed only conducts repo operations on stress dates, such as quarter- and year-end.
The central bank has been injecting liquidity since Sept. 17, when funding strains caused the rate on overnight general collateral repo to surge and pulled the fed funds rate above the target range. The Fed also started buying Treasury bills last month to add bank reserves and bring them back to or above levels last seen in early September.
However, not all policy makers were on board with either approach discussed at the meeting. Many participants opined that once an ample supply of reserves is established, there may be little need for either a standing repo facility or frequent actions.
While participants generally agreed they should continue to monitor the market effects of the Fed’s offerings, some called for further research on the role that the regulatory environment or other factors may have played in recent dislocations.
“The first strategy is let’s see how things evolve in the coming weeks and see how year-end goes,” said Barclays Plc strategist Joseph Abate. “The goal from the Fed is, ‘We want to do as little market invention as possible,’ and that’s making sure the level of reserves is ample.”
For Abate, the second step is introducing a standing repo facility, potentially in the first quarter at the earliest, to facilitate intraday liquidity.
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