REFILE-Fed market desk seeks to extend reverse repo testing

Wed Jan 8, 2014 4:00pm EST

NEW YORK Jan 8 (Reuters) - The Federal Reserve group that oversees the central bank's market operations will likely ask to extend the testing of a program intended to manage short-term interest rates, the minutes of the Fed's Dec 17-18 policy meeting released on Wednesday showed.

In late July, top Fed officials were briefed about a fixed-rate reverse repurchase facility that reduces the amount of cash that banks, money market funds and mortgage finance agencies hold as they exchange money to hold the Treasuries the central bank own overnight and earn interest at a rate set by the Fed.

Reverse repos go together with the interest the Fed pays on excess reserves and the term deposit facility are tools to control short-term interest rates when the central bank is ready to normalize rates from their rock-bottom levels.

By setting the reverse repo rate, the Fed basically forces banks and other financial institutions to compete for cash on the open market with even higher rates.

The testing of this reverse repo facility is scheduled to end on Jan. 29.

"The staff reported that they saw potential benefits to extending the exercise and in January would likely recommend a continuation along with possible adjustments to program parameters that could provide additional insights into the demand for a potential facility and its efficacy in putting a floor on money market rates," according to the latest Fed minutes.

The Fed adopted a near-zero interest rate policy in December 2008. It has kept its target on the federal rate or the overnight borrowing cost on excess reserves between banks in a range from zero to 0.25 percent.

The Fed has plenty of assets to reduce money supply after three rounds of massive bond purchases, or quantitative easing. These moves have more than tripled the size of the Fed's balance sheet to almost $4 trillion, with $2 trillion in Treasuries securities.

The central bank's market desk has been holding small-scale tests with primary dealers and money market funds since 2009 to determine its readiness to conduct reverse repos.

Since September, it has ramped up its testing by raising the interest rate on the reverse repos to as high as 0.05 percent and enlarging the amount of reverse repos a counterparty could conduct with the central bank.

The overnight repo rate was 0.04 percent Wednesday afternoon, little changed from late on Tuesday.

It also enlarged the amount of reverse repos the Fed could allocate to each counterparty to $3 billion from $1 billion.

On Dec. 31, the Fed market desk allocated $197.76 billion in reverse repos at an interest rate of 0.03 percent. This was the highest single-day test for this facility.

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