NEW YORK, July 10 U.S. primary dealers did not expect the Federal Reserve to start trimming its bloated balance sheet until early 2016, after the central bank finally raises interest rates, according to a survey conducted last month.
The regular survey, done by the Federal Reserve Bank of New York to help the Federal Open Market Committee members prepare for the June 17-18 policy-setting meeting, suggested many of the Fed's key messages in recent months have sunk in on Wall Street, including the expectation that rates in general will be lower than historical norms over the long run.
The U.S. central bank is still adding to its balance sheet, which is approaching $4.5 trillion after years of monetary accommodation. The primary dealers, which do business directly with the Fed, expect the central bank's balance sheet to swell a bit more this year and then flatline throughout 2015 before beginning to shrink in the first quarter of 2016.
They expect the Fed to lift its benchmark federal funds rate in the third quarter of next year, according to median responses from the 22 dealers polled between June 5-9. The New York Fed published the results as usual three weeks after the meeting, at which the Fed made little change to policy.
In a speech on May 20, New York Fed President William Dudley said he would prefer to keep reinvesting funds from maturing assets in the portfolio until sometime after the rate rise, which was a change from the Fed's previous plan. In the survey, several dealers cited that speech "as causing them to push back their expected timing" of the end of reinvestments.
The dealers also lowered predictions of where the fed funds rate would ultimately settle in the longer run - to 3.5 percent from 3.75 percent in the survey done six months earlier. The fed funds rate is the rate that banks charge each other for overnight loans.
"Some dealers noted their expectation for a lower longer-run federal funds rate as being driven by their perception of lower potential GDP growth," the poll results showed.
According to minutes of the Fed's June meeting, released on Wednesday, policymakers are indeed expecting to raise rates before shrinking the balance sheet.
The minutes also showed that officials are eyeing a relatively large spread of 20 basis points between a rate on overnight reverse repurchase agreements, or reverse repos, and a rate on excess bank reserves, known as IOER.
The survey telegraphed this, showing dealers expected the repo rate (O/N RRP) to be 0.28 percent and the IOER to be 0.50 percent once the Fed lifts its key fed funds rate, according to the median responses. They expected the fed funds rate would be 0.38 percent at this point.
Several dealers "put particular emphasis on the use of the O/N RRP rate and the IOER rate (and) noted that the federal funds rate may be de-emphasized in importance as a policy rate due to the diminished size of the federal funds market relative to the pre-crisis period," the survey said.
(Reporting by Jonathan Spicer; Editing by Jan Paschal)
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