Fed plans to sell term deposits to absorb $1 trn in excess reserves

Written by Bloomberg | Updated: Dec 31 2009, 04:56am hrs
The Federal Reserve proposed a programme to sell term deposits to banks to absorb some of the banking systems $1 trillion in excess reserves now threatening to accelerate inflation as the economy recovers.

The plan, subject to a 30-day comment period, has no implications for monetary policy decisions in the near term, the central bank said on Monday in a statement released in Washington.

Fed chairman Ben S Bernanke and his fellow policy makers are debating how to shrink or neutralise the inflationary impact from the biggest monetary expansion in US history. Some central bankers, including Richmond Fed president Jeffrey Lacker, have suggested that the Fed reduce excess reserves by selling Treasuries or mortgage-backed securities.

Term deposits may help policymakers assert operational control over the federal funds rate once they raise the interest rate from the current range of zero to 0.25%, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Excess cash would be locked up, easing downward pressure on the federal funds rate, he said.

The Fed has expanded its balance sheet to $2.2 trillion through several liquidity programmes, including purchases of $1.25 trillion in mortgage-backed securities. Excess reserves constitute cash held by banks in excess of what they are required to keep against deposits. The Fed proposal says the term deposits could be sold in an auction or through a formula.

The Fed wont begin raising interest rates until the third quarter of 2010, according to the median estimate of 62 economists surveyed by Bloomberg News in the first week of December.

Weve known for some time now that term deposits were on the Feds radar and were often treated as the next most likely tool for draining reserves after reverse repos, said Dan Greenhaus, chief economic strategist at Miller Tabak & Co LLC in New York.

In a reverse repurchase agreement, the Fed lends securities for a set period, draining cash from the banking system. At maturity, the securities are returned to the Fed, and the cash to the primary dealers that act as counterparties to the central bank.