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Tags: Fed | Unlikely | React | Overnight | Rate | Plunge | Goldman

Fed Unlikely to React to Overnight Rate Plunge, Goldman Says

Friday, 08 April 2011 03:21 PM

The Federal Reserve is unlikely to react to the plunge in overnight lending rates, which won’t interfere with policy markers’ ability to change monetary policy, according to Goldman Sachs Group Inc.

The effective federal funds rate dropped to as much as 0.16 percentage point below the rate the central bank pays banks on excess reserves, which is equal to the Fed’s zero to 0.25 percent target for overnight loans between banks. The effective rate, a volume-weighted average on trades by major brokers, was 0.09 percent on April 5, equaling the lowest since June.

The rate “is still perfectly consistent with the directive issued by the Federal Open Market Committee,” wrote a team of Goldman economists lead by Jan Hatzius, in an emailed note today. “The effective funds rate has been around current levels before: between September 2009 and January 2010 the funds rate averaged 12 basis points. Unless market functioning is seriously disrupted, we would not expect a Fed response.”

Cash in the banking system has risen this year, in part as Fed’s purchases of Treasuries boosted banks’ reserves parked at the Fed. Excess reserves have climbed to $1.431 trillion from $1.296 trillion a month ago, and $2.2 billion at the start of 2007. The Fed began paying interest on the reserves in October 2008 to keep the overnight interest rate traded in the market close to the target set by policy makers.

“The Committee seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to 1/4 percent,” according to the minutes of the Federal Open Market Committee’s March 15 meeting, which were published April 5.

Repo Market

Rate on repurchase agreements for government debt and Treasury bills also escalated a 2011 decline this week, guided down in part by the decline in the funds rate, as a cut in government bill sales on behalf of the Fed, central bank debt purchases and a Federal Deposit Insurance Corp. Insurance fee change msghelped trigger collateral shortages.

In a repurchase agreement, one party provides cash to another in exchange for a security, and vice versa. Repos are typically used to finance holdings, meaning movements in the rates affect the cost of holding the securities in inventory.

The Fed’s ability to pay interest on excess reserves will enable the central bank to drain the over $1 trillion added to the financial system to combat the financial crisis and lift rates when economic conditions warrant, wrote the economists at Goldman, one of the 20 primary dealers that act as counterparties on open-market operations with the central bank.

Excess Reserves

“The striking observation about the funds market today is that despite $1.4 trillion in excess reserve, the effective funds rate remains well above zero,” Hatzius wrote. “This is clear evidence that the payment of interest on excess reserves exerts a powerful force. That said, the recent variability in the funds rate may influence one aspect of the exit strategy: the way in which the FOMC communicates policy changes,” referring to a method that Fed Chairman Ben S. Bernanke already suggested last year, the Goldman economists added.

Bernanke in February 2010 testimony to the House Financial Services Committee stated that the Fed was considering the “utility, during the transition to a more normal policy configuration, of communicating the stance of policy in terms of another operating target, such as an alternative short-term interest rate.” Adding that, “in particular, it is possible that the Federal Reserve could for a time use the interest rate paid on reserves, in combination with targets for reserve quantities, as a guide to its policy stance, while simultaneously monitoring a range of market rates.”

© Copyright 2022 Bloomberg News. All rights reserved.

The Federal Reserve is unlikely to react to the plunge in overnight lending rates, which won t interfere with policy markers ability to change monetary policy, according to Goldman Sachs Group Inc.The effective federal funds rate dropped to as much as 0.16 percentage point...
Friday, 08 April 2011 03:21 PM
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