Fed to Conduct ‘Small Scale’ Triparty Reverse Repos (Update2)

Nov. 30 (Bloomberg) -- The Federal Reserve said it will test one of the tools for an eventual withdrawal of the central bank’s unprecedented monetary stimulus while stressing that the trials themselves don’t represent any change in policy.

The New York Fed said it will conduct “small scale, real value” three-way reverse repurchase transactions in coming weeks. The tests are “a matter of prudent advance planning by the Federal Reserve,” the statement said, and “no inference should be drawn about the timing of any change in the stance of monetary policy in the future.”

Policy makers led by Fed Chairman Ben S. Bernanke are considering how to withdraw the more than $1 trillion they have pumped into the financial system to combat the deepest recession since the 1930s. Along with raising the overnight bank lending rate, Fed officials have said they may use reverse repos, pay interest on excess bank reserves and sell securities directly to investors to withdraw or neutralize cash in the banking system.

“We don’t think it’s any indication that they’re likely to implement an exit strategy soon, or even in the next several quarters,” said Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc., one of 18 primary dealers that trade with the Fed. “It’s important for the Fed to make sure the market is aware that the tools they do have work, even if they’re not ready to use them yet.”

The Fed cut its benchmark interest rate to as low as zero last December and adopted asset purchases as its main policy tool. The Fed is buying $1.25 trillion of agency mortgage-backed securities and about $175 billion of housing agency debt. The Fed in October completed a $300 billion program of U.S. Treasury securities purchases.

Rate Outlook

The central bank probably won’t raise its benchmark interest rate above 0.25 percent until August, according to the median forecast of 45 economists surveyed by Bloomberg News.

The Fed on Nov 4. repeated it will keep interest rates near zero for “an extended period” and specified for the first time that policy will stay unchanged as long as inflation expectations are stable and unemployment fails to decline.

Payrolls in the U.S. probably fell by 120,000 workers this month, according to the median of 67 analysts surveyed by Bloomberg News ahead of a Dec. 4 Labor Department report. The unemployment rate probably held at 10.2 percent, a 26-year high.

The world’s largest economy has lost 7.3 million jobs since the recession began in December 2007. The jobless rate is projected to exceed 10 percent through the first half of next year, according to the median forecast of economists surveyed this month.

Treasury Notes

Treasury notes were little changed today. The 10-year note’s yield increased one basis point, or 0.1 percentage point, to 3.21 percent at 1:36 p.m. in New York.

The reverse repo transactions are being conducted to ensure “operational readiness” at the Fed, clearing banks and primary dealers, today’s statement said. They will have “no material impact” on the availability of reserves or on market interest rates, it said.

“You could look at it as a case of due diligence by the Fed,” said Ward McCarthy, chief financial economist at Jefferies & Co., also a primary dealer.

In a reverse repo, the Fed loans securities for a set period. At maturity, the securities are returned to the Fed, and the cash to the dealers.

Market Rates

The transactions will be conducted at current market rates, and the aggregate amount outstanding “will be very small relative to the level of excess reserves,” today’s announcement said. The results will be posted on the New York Fed’s Web site and will be listed as liabilities on the Fed’s consolidated balance sheet statements.

The New York Fed said on Oct. 19 that it was working with market participants on how it would use reverse repurchase agreements to help drain cash. It also said the central bank was considering expanding the counterparties for reverse repo operations beyond the 18 primary dealers.