Fed boosts auction size in surprise action
The Federal Reserve on Friday announced emergency measures to add $200 billion into the banking system in a bid to ease persistent liquidity strains that are leading to a global credit freeze.
The Fed said it would increase the size of its two term auctions of short-term funding to banks this month to $100 billion from the $60 billion previously announced. It also would start a series of term repurchase transactions with the primary dealers that trade securities directly with the Fed, expected to be worth a total of $100 billion.
The two measures are intended to address heightened liquidity pressures in term funding markets, the Fed said in a surprise announcement.
The move coincided with unexpectedly somber news that U.S. employers cut 63,000 jobs in February, the second consecutive month of job losses. Senior Fed staff said their announcement was not related to the jobs report but rather a reaction to a broad recognition that financial market deterioration had accelerated in recent days.
HEADWINDS FOR THE FED
As the Fed sought to ease financial strains with liquidity measures, Fed officials highlighted the simultaneous difficulty the central bank faces in reviving the sluggish economy with interest rate cuts.
In the current situation, monetary stimulus is facing significant headwinds ... In these circumstances, a central bank may have to ease policy more in order to achieve its desired effect, Kansas City Fed President Thomas Hoenig said in a speech in Rio de Janeiro.
But he warned there will be a buildup of inflationary pressures if rates stay too low for too long.
The dollar rebounded from record lows as the liquidity moves fueled speculation the Fed might be more restrained in cutting interest rates after February's job losses, and short-term Treasuries prices fell.
However, recession warning bells sounded by the bleak employment report sent stocks to their lowest close in 19 months, and long-maturity Treasury prices rose.
The Fed will aim to keep the Fed funds rate around its target despite the expanded auctions, senior central bank staff told reporters. They spoke on condition of anonymity and that they not be quoted directly.
The Fed unveiled its Term Auction Facility late last year to provide liquidity directly to the banking sector without compelling banks to access the Fed's discount window. Repurchase agreements are used routinely by the Fed to manage day-to-day liquidity and allow the Fed to inject liquidity directly to the 20 primary dealers.
In its statement on Friday, the Fed said it would increase amounts in its March 10 and March 24 term auctions to $50 billion each, a rise of $20 billion at each auction.
PERSISTENT PRICE PRESSURES
The New York Fed said separately it will sell $10 billion of its Treasury bill holdings in conjunction with the liquidity measures to preserve its bank reserve and policy rate targets.
The actions come as financial market turmoil festers despite aggressive rate cuts and liquidity infusions.
Meanwhile, Fed officials, speaking at events in Europe, said the U.S. central bank is keeping a watchful eye on inflation. The Fed has slashed benchmark rates by 2.25 percentage points since September, to 3 percent, saying its main concern is that sluggish growth could slow more than expected.
Policy-makers must be mindful of the uncertainties surrounding the outlook for commodity prices and the risk that past or future increases in these goods could yet embed themselves in higher long-run inflation expectations and a persistently faster rate of overall price increases, Fed Vice Chairman Donald Kohn said at a Bank of France seminar in Paris.
At the same time, the U.S. economy is particularly exposed to risks from the unwinding of the housing bubble and disruptions in financial markets, San Francisco Fed President Janet Yellen, said at the same seminar.
Analysts said the Fed's moves on Friday make it less likely the central bank will cut benchmark rates before its scheduled March 18 meeting. Markets now widely expect the Fed to slash rates by at least a half-percentage point at that meeting.
It's important that the Fed took steps to ease liquidity pressures since money markets are clearly suffering another bout of turmoil, said Jane Caron, chief economic strategist at Dwight Asset Management in Burlington, Vermont.
The central bank also said it would increase the amounts of the March auctions if conditions warrant. It said that in a bid to provide increased certainty to market participants, it would conduct term auctions for at least the next six months unless market conditions stabilize to the point such auctions are unnecessary.
Also, underscoring concern about the global reach of market turmoil, the Fed said it is in close consultation with foreign central bank counterparts about liquidity concerns.
Fed staff declined to provide more details about those consultations.
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