Magazine article Economic Trends

Supplying Liquidity: The Tried and True and the New

Magazine article Economic Trends

Supplying Liquidity: The Tried and True and the New

Article excerpt

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On April 30, 2008, the Federal Open Market Committee (FOMC) voted to lower its target for the federal funds rate by 25 basis points to 2 percent. Since this latest round of rate cuts began in September 2007, the federal funds rate has been lowered a total of 3.25 percent. The FOMC's statement noted that "economic activity remains weak" and that "financial markets remain under considerable stress." The committee also pointed to some improvement in core inflation but cautioned that "energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months." Richard Fisher and Charles Plosser preferred no change in the funds rate and voted against the committee's action.

In the days prior to the meeting, participants in the Chicago Board of Trade's federal funds options markets placed around a 70 percent probability on a 25 basis point cut at the April meeting. Nearly a 25 percent probability was placed on no change.

The options market places over a 70 percent probability on a pause at the June meeting. Looking further ahead, participants in the federal funds futures market have raised their projected path of the funds rate in recent weeks. Currently, participants in the futures market foresee little change in the funds rate over the next few meetings.

With the onset of financial turmoil in the Fall of 2007, the Federal Reserve has implemented a number of facilities to enhance market liquidity and the functioning of financial markets. December brought the introduction of the Term Auction Facility (TAF), which auctions a predetermined amount of funds to depository institutions that are eligible for primary credit. Total bids for TAF funds continue to exceed the amount offered by nearly 2 to 1, even though the biweekly auction sizes were increased to $50 billion in March. In contrast, the April 10 and April 24 Term Securities Lending Facility's (TSLF) auctions of securities were undersubscribed, with bids totaling less than the amount offered. Under the TSLF, which was introduced in March, the Trading Desk of the New York Fed lends liquid Treasury securities to primary dealers in exchange for a broader set of collateral. On May 2, the Federal Reserve announced changes to the TAF and TSLF facilities. Beginning May 5, the size of the biweekly TAF auctions will be increased from $50 billion to $75 billion. In addition, securities eligible as collateral for Schedule 2 TSLF auctions will be expanded to also include AAA/Aaa-rated asset-backed securities. …

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