Bernanke’s cash injections risk eclipse of Fed’s benchmark rate

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Nov 19 : The Federal Reserve's efforts to rescue the US from financial collapse risks the eclipse of their benchmark interest rate as the most important signal of monetary policy.

Record injections of liquidity have driven the overnight lending rate between banks to less than half the 1 % target set by officials last month. The gap is shifting investors' focus toward the amount of money in the banking system as a better gauge of Fed intentions, something San Francisco Fed President Janet Yellen last month called “a kind of quantitative easing.” “There has been a policy shift, but the Fed is not transparently announcing what it is doing and why,” said former St. Louis Fed President William Poole, now a senior fellow at the Cato Institute in Washington. “Monetary policy works best when the markets understand what the central bank is doing.”

The Fed's failure to meet its target risks pricing billions of dollars in short-term debt at interest rates lower than the Federal Open Market Committee intends. It also makes it harder for traders to bet on the central bank's future course of monetary policy. “A major signal of Fed policy intent, the effective funds rate, has become irrelevant,” said Stan Jonas, who trades interest-rate derivatives at Axiom Management Partners LLC in New York. Some analysts point to the surplus cash that banks keep on deposit at the Fed as a key gauge of the Fed's monetary-policy stance. The so-called excess reserves have ballooned to $363.6 billion from $2 billion in August as the Fed added to its emergency lending programs.

“It is a move to quantitative easing, to force lots and lots of reserves into the banking system with the expectation that banks will start to trade them for a higher-yielding asset,” said Poole, a Bloomberg contributor, said yesterday in a Bloomberg Television interview.