By Michael S. Derby
June 30 (Reuters) - The Federal Reserve's rebuild of money market liquidity is pointing to a quiet turn of the quarter, market participants say, as ample central bank cash depresses the volatility that often emerges around such calendar dates.
Heading into the quarter-end, market participants do not see market pressure growing in a way that would point to a spasm of interest rate volatility and a surge in use of central bank liquidity facilities.
“I expect normal turn-of-the-quarter
pressures but nothing disruptive,” said Lou Crandall, chief economist with research firm Wrightson ICAP.
On Monday, there was no borrowing via the Fed’s standing repo operations and reverse repo inflows were marginal, as they have been for some time, in a sign that Tuesday’s trading is fixing to be calm.
The month-end often brings short-lived bouts of money market churn as some market participants pull back, which can then pressure rates upward and drive various market players to either park cash at the Fed’s reverse repo facility or borrow from the Fed via repo operations. Those pressures are frequently strongest at quarter-end as firms manage their respective balance sheets. To the extent there is churn, it usually dissipates quickly.
But this time, as was the case at year-end and at the close of March, the Fed is adding cash to the market as part of a technical effort to manage money market conditions, to ensure it retains firm control of its interest rate target range and to allow for normal market volatility.
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At the end of last year, the Fed embarked on $40 billion per month in Treasury bill buying to ensure the market would have enough liquidity on hand to navigate the mid-April tax date. It has moderated that monthly pace to $10 billion amid an ongoing debate about the future of that technical buying, and the central bank balance sheet as a whole.
“At this point, I’m still assuming another $10 billion of RMPs in the July-August cycle, but wouldn’t be surprised by anything from zero to, say, $15 billion,” Crandall said.
BMO Capital Markets strategists said in a note on Monday that they believe the Fed will stick with $10 billion per month in Treasury bill buying into late summer. The firm added that current money market rates indicate “relatively modest quarter-end pressures in the funding market.”
But they added: “If the softer tone persists as [the third quarter] gets under way, there is a risk that the Fed reduces or temporarily halts reserve management purchases.”
The Treasury bill buying, known by the central bank as reserve management purchases, has been happening in the shadow of a broader debate about the overall size of the Fed’s balance sheet.
Newly installed Chairman Kevin Warsh is a skeptic of the Fed’s still large balance sheet and he wants it to be smaller. He said at the Federal Open Market Committee meeting earlier this month that he would be appointing a task force to study the matter.
Many economists as well as some central bankers agree the Fed’s balance sheet can be made smaller by changing the rules to allow banks to hold less highly liquid cash, though that would likely increase financial stability risks. That could help to get Fed holdings down by as much as $1 trillion, from the current $6.7 trillion level.
But analysts do not expect swift action. In particular, any effort to allow banks to hold less cash must be done very carefully, if the Fed is to preserve its paramount focus on interest rate control.
(Reporting by Michael S. Derby; Editing by Edmund Klamann)
