By Steven K. Beckner

(MNI) – The Federal Reserve will move forward soon with what it
calls “small-value” auctions of term deposits under its newly created
Term Deposit Facility, the central bank announced Friday.

The first auction of $1 billion in 14-day term deposits will be
conducted June 14.

The announcement comes on the heels of the Federal Reserve Board of
Governors’ April 30 action amending its Regulation D, governing reserve
requirements of depository institutions, to authorize the 12 Federal
Reserve Banks to offer term deposits of varying maturities through a
Term Deposit Facility or TDF.

The TDF will be offering what amount to certificates of deposit to
banks and other eligible financial institutions, which do not include
government sponsored enterprises (GSEs) such as Fannie Mae and Freddie
Mac.

The TDF is being developed and tested to give the Fed another tool
for draining or absorbing excess reserves when the time comes. The three
auctions that have been scheduled will be relatively modest in size and
the Fed stressed that they will be conducted as “a matter of prudent
planning” and do not have monetary policy implications.

The TDF will be just one tool the Fed can use in those eventual
reserve draining operations. Reverse repurchase agreements, which are
also being tested, are the other major instrument expected to be used at
some point to drain sizable amounts of reserves to reverse the Fed’s
quantitative easing policies and help lift money market rates.

The Fed is also paying interest on reserves, which the Fed hopes
will enable it to set a floor under the funds rate and incentivize banks
to hold reserves rather than expand lending overly aggressively.

Although the TDF would not shrink the balance sheet, the Fed
considers that the TDF would “drain reserves” in the sense that the
amounts which banks place in term deposits would no longer be counted as
reserves in banks’ “master accounts” at the Federal Reserve Banks.

Term deposits could not be used to satisfy required reserve
balances or contactual clearing balances, are not considered “excess
reserves” and could not be used to clear payments or reduce daylight
overdrafts.

For now, the Fed is still in the testing stage. Fed sources have
indicated that before the Fed begins actually tightening monetary
policy, the Federal Open Market Committee will probably first change its
policy guidance (the “extended period” language); then pre-announce
sizable reserve draining operations; then raise the interest rate on
excess reserves (IOER) and the federal funds rate target, and only later
sell assets.

In announcing three “small value auctions” of term deposits, the
Fed emphasized, “These auctions are a matter of prudent planning and
have no implications for the near-term conduct of monetary policy.”

The Fed announced that “all term deposit auctions will use a
single-price format in which all winning bids will be awarded at the
highest rate accepted at the auction.”

The first auction will offer $1 billion of 14-day term deposits;
the auction will be conducted on June 14 with settlement on June 17, and
the deposits offered will mature on July 1.

Each participating institution may submit up to three competitive
bids; the maximum award to any individual bidder will be set at $250
million and the maximum rate at the auction will be set at the primary
credit rate.

Depository institutions may submit noncompetitive bids; each
individual noncompetitive bid will be filled up to a limit of $5 million
at the highest rate accepted in the competitive auction. The amounts
awarded to noncompetitive bidders will be added on to the $1 billion
offered at the competitive auction.

The second auction will offer 28-day term deposits; the auction
will be conducted on June 28 with settlement on July 1, and the deposits
offered will mature on July 29.

The third auction will offer 84-day term deposits; the auction will
be conducted on July 12 with settlement on July 15, and the deposits
offered will mature on October 7.

The amount of term deposits offered along with other parameters for
the second and third auctions will be announced at a later date.

The Fed said it “may schedule up to two additional small-value TDF
auctions later in the summer.”

The Fed plans to provide additional details of the first auction on
June 11 on the TDF Resource Center at

http://www.frbservices.org/centralbank/term_deposit_facility.html.

** Market News International **

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