NEW YORK (Reuters) - The New York Federal Reserve on Monday said it accepted $11.81 billion in cash as part of the first test of a new reverse repo tool that is meant to help control short-term interest rates.
In reverse repurchase agreements, or reverse repos, the Fed temporarily drains cash from the financial system by borrowing funds overnight from banks, large money market mutual funds and others, and offering them Treasury securities as collateral. Banks and the funds receive a modest overnight interest rate, initially set at 0.01 percentage point, or 1 basis point.
The tool is designed to mop up excess cash in the financial system, which if left unchecked could keep rates lower than perhaps desired by the Fed at a later date. If successful, the reverse repos could smooth what may be a rocky transition to tighter monetary policy when the U.S. central bank finally decides the economy is strong enough to withstand higher interest rates.
New York Fed President William Dudley on Monday sought to dispel misconceptions that the introduction of the tool represents a change in monetary policy, saying it is meant only to help improve the Fed’s control of overnight interest rates.
“Even if our balance sheet increases significantly further and stays very large for many years, it will be useful to have this facility available to improve monetary policy control,” Dudley said.
Talk of the new tool surfaced in minutes of the Fed’s last policy meeting in late July, with little explanation beyond a general agreement among top officials that a “fixed-rate, full-allotment overnight reverse repurchase agreement facility” could prove to be helpful.
The statement and subsequent testing of the facility have caused anxiety that the Fed may be closer to tightening economic conditions than had previously been expected, resulting in a small uptick in the volatility of Treasuries bills.
Many traders, however, see the fears as overstated as they see the implementation of the facility still far away.
By broadening the number of firms that the Fed deals directly with in the operation to include buyside firms, including money funds and government-sponsored enterprises, the Fed also hopes it can better increase stability of short-term rates than if it were to deal only with banks.
“This competitive effect could, in and of itself, put a stronger floor on money market rates.” Dudley said.
The Fed surprised investors last week by not reducing the size of its $85 billion-a-month bond-purchase program, though officials including Chairman Ben Bernanke said it is still possible that the size will be reduced this year.
Reporting by Jonathan Spicer; Editing by Leslie Adler