Reuters: US Dollar Report: MONEY MARKETS-Fed staff seen downplaying reserve rate cut

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MONEY MARKETS-Fed staff seen downplaying reserve rate cut Aug 29th 2012, 20:56 Wed Aug 29, 2012 4:56pm EDT * N.Y. Fed blog raises issues from negative rates * Fed staff raises possible drawbacks on cutting IOER By Richard Leong NEW YORK, Aug 29 (Reuters) - U.S. Federal Reserve researchers this week downplayed the chances that the central bank would reduce the interest it pays banks on their excess reserves in order to stimulate lending. Cutting the interest on excess reserves (IOER) that banks park at the Fed could knock short-term interest rates into negative territory, disrupting money markets and the bank systems, two senior New York Fed staffers argued in a blog on Wednesday. That came two days after a separate blog post from a pair of Fed economists arguing that cutting IOER would not alter lending habits and as such would do little to boost the economy. Analysts say the timing of the two blogs from Fed staffers was coincidental and had no connection with the current thinking of policymakers. A New York Fed spokeswoman declined to comment. Still the issues raised are in step with the concerns some Fed officials expressed at the central bank's last policy meeting, according to the July 31-Aug. 1 meeting minutes. If interest rates go negative as a result of the Fed cutting the IOER to zero, the possible reactions among consumers and banks could be "socially unproductive," New York Fed staffers Kenneth Garbade and Jamie McAndrews said in a blog published Wednesday on the New York Fed's website. Garbade is a senior vice president in the money and payments studies function at the New York Fed's research group and McAndrews a research director at the bank. They added that negative short-term rates might create "new risks that are not fully priced by market participants." Negative interest rates could further squeeze the $2.5 trillion U.S. money market fund industry which has already been struggling with near zero rates, analysts said. If the Fed were to cut IOER, driving money fund share prices below zero so they "break the buck," investors could rapidly withdraw money from these funds, causing market turmoil like that seen after the collapse of Lehman Brothers in September 2008. "These are clear trial balloons," said Howard Simons, a strategist at Bianco Research in Chicago. Cutting the IOER is "not really a good idea." Garbade and McAndrews' blog was the second in three days in which Fed staffers highlighted the drawbacks of cutting the IOER, a move some economists have said could spur lending. On Monday, Gaetano Antinolfi, a Fed senior economist, and Todd Keister of the New York Fed's research and statistics group, said reducing IOER would do little to change the amount of reserves banks leave with the central bank. "The quantity of balances banks hold on deposit at the Fed would be essentially unaffected by a change in the IOER rate," they wrote. Simply reducing what the Fed pays on excess reserves would not encourage all banks to lend businesses or consumers, leaving the overall amount of excess reserves little changed, they said. Jeremy Lawson, a senior economist at BNP Paribas, said the pair of Fed economists was "debunking the myth that IOER is hampering business lending." Traders have been speculating the Fed will embark on more policy stimulus at its Sept. 12-13 meeting with bets Fed Chairman Ben Bernanke would hint at further easing on Friday at a gathering of global central bankers in Jackson Hole, Wyoming. Most of the traders' focus has been on further quantitative easing (QE) in the form of large scale bond purchases. There has also been chatter the Fed might extend its commitment to keep short-term rates near zero. Markets consider cutting the IOER the least likely option for the Fed, although the idea of such a move was revived after the European Central Bank cut a similar rate to zero earlier this summer in a bid to help the region's economy. "I've never thought it is an effective tool like QE," BNP's Lawson said. Link this Share this Digg this Email Reprints

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