The Federal Reserve’s second auction to test its system of selling term deposits yesterday sold $2.12 billion of deposits.
The Fed offered $2 billion for 28 days through the Term Deposit Facility and received bids worth $11.1 billion, making the bid-cover ratio 5.57, the central bank said in a statement today. Successful bidders will deposit money with the Fed on July 1 and earn interest of 0.27 percent, the same rate as at the first auction. Banks currently receive 0.25 percent in interest on excess reserves.
Fed policy makers led by Chairman Ben S. Bernanke are preparing for the day when they will have to start siphoning off more than $1 trillion in excess reserves from the banking system to prevent an outbreak of inflation. The term deposit facility and reverse repurchase agreements are among the programs they have said they will deploy to raise their target interest rate for overnight lending among banks.
The term-deposit tests “are a matter of prudent planning and have no implications for the near-term conduct of monetary policy,” the Fed said when the schedule of auctions was announced last month.
In exchange for leaving their money in the Fed’s term deposit facility, banks receive a premium on their funds. The winning bid in both auctions was for 0.27 percent, or 2 additional basis points of interest. A basis point is 0.01 percentage point.
The second test of the Term Deposit Facility attracted 107 participants, compared with 109 participants for the first test. In addition to $2 billion awarded through competitive bidding, the Fed said it received $121.9 million in non-competitive bids.
The Fed has also tested the reverse repurchase agreements it intends to use as part of its so-called exit strategy from its unprecedented expansionary monetary policy. In a reverse repo, the Fed lends securities for a set period. At maturity, the securities are returned to the Fed, and the cash to the primary dealers. The Fed conducted five trials of this system in December.
“The use of reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so,” Bernanke told Congress in March.
In addition to using the Term Deposit Facility and reverse repos to temporarily tie up funds, Bernanke and his colleagues plan to eventually sell the Fed’s holdings of mortgage-backed securities to cut the central bank’s balance sheet from its current level of $2.35 trillion to less than $1 trillion, its size before the financial crisis.
At the June 22-23 meeting of the Federal Open Market Committee, the central bank signaled it’s not ready to begin its exit from its unprecedented expansionary policy. The Fed pledged to keep rates low for an “extended period” and said that “financial conditions have become less supportive of economic growth.”
Economists such as Avery Shenfeld, chief economist at CIBC World Markets in Toronto, and former Richmond Fed President J. Alfred Broaddus, said the weakness in the economy increased the chance that the Fed would resume expanding its balance sheet.
The Fed may conduct three additional tests of the program. An auction for 84-day deposits will be held July 12. Two further tests may be scheduled later in the summer, the central bank said last month.
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