Federal Reserve officials will probably seriously consider a new tool to contain short-term interest rates as they deliberate over when to start expanding the central bank’s balance sheet again, former New York Fed President William Dudley said.
"They’ll increase the size of their balance sheet. So, they’ll start to buy Treasury securities again," Dudley said Monday during an interview on Bloomberg TV.
"And the second thing that they are going to strongly consider, I think, is introducing a standing repo facility, so whenever there is upward pressure on short-term rates, there is a facility that people can come to and do repo with, and that would sort of take away any risk of a big upswing," he said.
Dudley spoke following a week of intense volatility in money markets, and especially the market for repurchase agreements, known as repos. In a repo transaction, firms borrow cash, often overnight, and put up securities as collateral.
Short-term interest rates jumped amid last week’s strain, which resulted from a cash shortage after the Treasury issued debt and corporations paid down taxes. That crunch pulled the U.S. central bank’s benchmark rate above the target range and forced the New York Fed to intervene with overnight cash repo loans for the first time in a decade to quell the surge.
The New York Fed took some criticism for its delayed response to the turmoil, which began on Sept. 16. It waited until the next morning to signal it would intervene, and by the time it had, many of the day’s repo trades had already been done, making the intervention less effective than it otherwise would have been.
"In the scheme of things, maybe one day — would’ve been nice if they had responded maybe a little bit more quickly — but in the scheme of things, this is an event for markets. It’s not an event for the economy at all," Dudley said. "And where are we today? We’re in a good place — repo rates are now back down to where they should be, the federal funds rate is well within its range — so, mission accomplished."
