More permanent role seen for Fed's repurchase programme
By Michael Flaherty and Howard Schneider
STONE MOUNTAIN, Ga. (Reuters) - A pledge by the U.S. Federal Reserve to phase out a new tool to lift interest rates is being challenged by economists and financial professionals who think the central bank may need to keep using it longer than Fed officials expect.
As the Fed approaches an interest rate hike - expected later this year - it will use a suite of tools, including an overnight reverse repurchase facility (ON RRP) for money market funds to help lift its traditional federal funds rate from near zero.
The notion of making the repurchase programme a more permanent fixture at the Fed reflects the increasing role that non-bank lenders, also known as shadow banks, are playing in the U.S. borrowing market.
Years of monetary stimulus and new capital requirements has left the overnight federal funds market for banks a quarter of its pre-crisis size. Non-bank lending, meanwhile, has risen above pre-crisis levels, and comprises around 40 percent of U.S. credit.
That dynamic has made it necessary for the Fed to use the ON RRPs, or repos, to mop up excess cash sloshing around in the system to bump rates higher.
The Fed has said it will shutter the repo programme as soon as it's no longer needed, with Atlanta Fed President Dennis Lockhart saying on Wednesday that the central bank can adjust rates in a way to where the programme "dies under its own weight."
But central bank staffers and finance professionals at an Atlanta Fed conference here this week suggested a longer time horizon.
"Changes in short-term interest rates are less relevant to the price of a lot of credit," said New York Fed Senior Vice President Adam Ashcraft. "The question is how important is the overnight rate that we have control over? Is that losing its relevance?"
Boston Fed Vice President Joe Peek said the central bank may have to make its new tools for controlling rates a permanent feature of monetary policy.
"I think we need a larger toolkit, there is no question in my mind," said Peek, who joined Ashcraft on a Tuesday panel here. "The overnight repo and the interest on reserves will change how markets work (and) are going to be key to raising interest rates."
Paul McCulley, a former economist at Pimco, said he didn't think the federal funds rate was relevant anymore.
"I think the reverse repo rate is the natural instrument" for the Fed, McCulley said.
(Additional reporting by Jonathan Spicer in New York; Editing by Chizu Nomiyama)
