Fed's cash infusion less than what meets the eye
The amount of cash the Federal Reserve injected into the US banking system on August 9 and 10, and its importance, have been widely misunderstood.
By Agencies |
WASHINGTON: The amount of cash the Federal Reserve injected into the US banking system on August 9 and 10, and its importance, have been widely misunderstood. Each day banks are open, the people working at the New York Federal Reserve Bank’s ninth floor Open Market Desk do the same thing: supply enough money to the US banking system to keep the overnight lending rate close to the Fed’s 5.25% target.
August 9 and 10 were different only in degree, and in the attention the Fed called to the action in a statement issued on the latter day. There was no hint of an interest rate cut — nor is there likely to be unless conditions in world financial markets worsen considerably and threaten continued economic growth in the US.
“In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets,” the Fed statement said. In other words, the demand for funds to lend might drive the rate above the desired 5.25% level, and the Fed promised to supply enough cash to hold it down. The desk added $24 billion on Thursday and $38 billion on Friday. However, just stating those figures tends to exaggerate their importance. For instance, as recently as August 2, $17 billion had been added and everyone yawned. Furthermore, by the end of the Monday essentially all the additional liquidity injected to calm markets had been withdrawn.
The New York Fed, acting on behalf of the entire Federal Reserve System, adds cash by entering into repurchase agreements with a group of so-called primary dealers. From the dealers the bank buys Treasury securities, federal agency debt and mortgage- backed securities partially or entirely guaranteed by the government, such as those issued by Fannie Mae and Freddie Mac, for a set period — often as short as overnight. The cash paid to the dealers then finds its way into the banking system.
Routinely, a substantial amount of cash is added each Thursday for a 14-day period. Half of last Thursday’s injection was of that type. The other $12 billion was left in the banking system just overnight, that is, the New York Fed returned the securities on Friday and took back the cash. Even in the calmest of times it’s no easy task to figure out exactly how much needs to be added, and Friday was particularly difficult.
The lending rate jumped around, ranging from zero to just over 6%, as the desk found it necessary to step in three times, adding $19 billion at 8:25 am (local time) another $16 billion at 10:55 am (local time) and finally $3 billion at 1:50 pm (local time), according to the New York Fed. All that $38 billion was returned to the Fed on Monday.
With markets under far less pressure, that money was replaced by new agreements of just $2 billion, much less than the usual daily total. So the Fed actions were truly temporary and just intended to calm markets. In contrast, a cut in the 5.25% lending rate target, a step which many analysts have urged the Fed to take, would have a much greater, longer lasting impact. It was only a week ago today that the Federal Open Market Committee reaffirmed that target and said it was more concerned that inflation won’t moderate as expected than that economic growth would become excessively weak.
Moderate growth still was seen as the most likely course for the economy over coming quarters, the committee said.
On August 10, after the markets closed, Macroeconomic Advisers released its latest economic forecast, one very similar to the collective forecast of Fed officials.
The new predictions include gross domestic product expanding at about a 2.5% annual rate in the second half of this year, rising to about a 2.75% rate early next year. “Core inflation is projected to remain stable at the upper end of the Fed’s ‘comfort zone’ of about 2% for core personal consumption expenditure inflation and 2.25% for the core consumer price index inflation, as well-anchored inflation expectations and a gradually rising unemployment rate offset upward pressure on growth of labour costs,” the company’s explanation of the forecast said.
Fed officials will be watching what happens next and will respond to disorderly market conditions, with those folks on the Open Market Desk their front-line troops. Bailing out ailing hedge funds or propping up the stock market isn’t on their agenda, however.
August 9 and 10 were different only in degree, and in the attention the Fed called to the action in a statement issued on the latter day. There was no hint of an interest rate cut — nor is there likely to be unless conditions in world financial markets worsen considerably and threaten continued economic growth in the US.
“In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets,” the Fed statement said. In other words, the demand for funds to lend might drive the rate above the desired 5.25% level, and the Fed promised to supply enough cash to hold it down. The desk added $24 billion on Thursday and $38 billion on Friday. However, just stating those figures tends to exaggerate their importance. For instance, as recently as August 2, $17 billion had been added and everyone yawned. Furthermore, by the end of the Monday essentially all the additional liquidity injected to calm markets had been withdrawn.
The New York Fed, acting on behalf of the entire Federal Reserve System, adds cash by entering into repurchase agreements with a group of so-called primary dealers. From the dealers the bank buys Treasury securities, federal agency debt and mortgage- backed securities partially or entirely guaranteed by the government, such as those issued by Fannie Mae and Freddie Mac, for a set period — often as short as overnight. The cash paid to the dealers then finds its way into the banking system.
Routinely, a substantial amount of cash is added each Thursday for a 14-day period. Half of last Thursday’s injection was of that type. The other $12 billion was left in the banking system just overnight, that is, the New York Fed returned the securities on Friday and took back the cash. Even in the calmest of times it’s no easy task to figure out exactly how much needs to be added, and Friday was particularly difficult.
The lending rate jumped around, ranging from zero to just over 6%, as the desk found it necessary to step in three times, adding $19 billion at 8:25 am (local time) another $16 billion at 10:55 am (local time) and finally $3 billion at 1:50 pm (local time), according to the New York Fed. All that $38 billion was returned to the Fed on Monday.
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With markets under far less pressure, that money was replaced by new agreements of just $2 billion, much less than the usual daily total. So the Fed actions were truly temporary and just intended to calm markets. In contrast, a cut in the 5.25% lending rate target, a step which many analysts have urged the Fed to take, would have a much greater, longer lasting impact. It was only a week ago today that the Federal Open Market Committee reaffirmed that target and said it was more concerned that inflation won’t moderate as expected than that economic growth would become excessively weak.
Moderate growth still was seen as the most likely course for the economy over coming quarters, the committee said.
On August 10, after the markets closed, Macroeconomic Advisers released its latest economic forecast, one very similar to the collective forecast of Fed officials.
The new predictions include gross domestic product expanding at about a 2.5% annual rate in the second half of this year, rising to about a 2.75% rate early next year. “Core inflation is projected to remain stable at the upper end of the Fed’s ‘comfort zone’ of about 2% for core personal consumption expenditure inflation and 2.25% for the core consumer price index inflation, as well-anchored inflation expectations and a gradually rising unemployment rate offset upward pressure on growth of labour costs,” the company’s explanation of the forecast said.
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The core measures of inflation exclude food and energy items. The core PCE price index is the Fed’s preferred inflation measure. In language similar to that in the August 7 FOMC statement, Macroeconomic Advisers also said, “Recent credit-market turmoil has skewed risks to the downside around this forecast.” Obviously the rush to shed risky investments triggered by losses in subprime mortgage-backed securities isn’t over. Fed officials will be watching what happens next and will respond to disorderly market conditions, with those folks on the Open Market Desk their front-line troops. Bailing out ailing hedge funds or propping up the stock market isn’t on their agenda, however.
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