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Fed Asks Dealers to Estimate Size of Debt Purchases

Ben S. Bernanke, chairman of the U.S. Federal Reserve
Ben S. Bernanke, chairman of the U.S. Federal Reserve. Photographer: Tomohiro Ohsumi/Bloomberg

The Federal Reserve asked bond dealers and investors for projections of central bank asset purchases over the next six months, along with the likely effect on yields, as it seeks to gauge the possible impact of new efforts to spur growth.

“If they buy too much, I think there’s a real chance that rates are going to rise because people are worried about inflation,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. “If they don’t buy much, they’re not going to have a market impact.”

The New York Fed survey, obtained by Bloomberg News, asks about expectations for the initial size of any new program of debt purchases and the time over which it would be completed. It also asks firms how often they anticipate the Fed will re-evaluate the program, and to estimate its ultimate size.

With their benchmark interest rate near zero, policy makers meet Nov. 2-3 to consider steps to boost an economy that’s growing too slowly to reduce unemployment near a 26-year high. Financial-market participants are focusing on the size, timing and maturities of likely purchases aimed at lowering long-term rates, with estimates reaching $1 trillion or more.

William Dudley, president of the New York Fed and vice chairman of the Federal Open Market Committee, set expectations of about $500 billion for a new round of so-called quantitative easing, or QE, a figure he used in an Oct. 1 speech.

Investor Concern

“QE is a very hot topic right now and will be a major factor for us,” Tom Tucci, head of U.S. government bond trading in New York at Royal Bank of Canada’s RBC Capital Markets unit, one of 18 firms that trade directly with the Fed, said in an interview today with Bloomberg Television. “We feel that the need for this is about $100 billion a month.”

Treasury 10-year notes rose for the first time in seven days today, pushing the yield down six basis points, or 0.06 percentage point, to 2.66 percent as of 3:52 p.m. in New York. The yield climbed to the highest in more than a month yesterday on speculation that the Fed will buy less debt than some traders had been expecting.

The New York Fed surveyed primary dealers and requested responses by Oct. 25. Among other questions, it sought reactions to Chairman Ben S. Bernanke’s speeches at regional Fed conferences at Jackson Hole, Wyoming, on Aug. 27, and in Boston on Oct. 15.

“The New York Fed regularly asks primary dealers and some buy-side firms about their expectations for the economy and Fed policy,” Deborah Kilroe, a spokeswoman, said. “This is just one of many pieces of information provided to the FOMC to ensure that policymakers have all the relevant facts they need to make informed judgments.”

Changes to Statement

In the survey, dealers assigned percent chances to the Fed easing through communications changes in the FOMC statement, additional purchases, or some other means. They were also asked how communications might change, and how the Fed might carry out new purchases.

Another question asked dealers to estimate changes in nominal and real 10-year Treasury yields “if the purchases were announced and completed over a six-month period.” The amounts dealers chose from were zero, $250 billion, $500 billion and $1 trillion.

“Yields would have to back up” if the market is overestimating the size of Fed purchases, said Joseph Abate, money-market strategist at Barclays Capital Inc. in New York. “The dealer community is running much less leverage than they did before. The amounts of inventory they are financing is smaller. Their capacity to absorb extra supply is lower.”

Treasury Questionnaire

The Fed’s survey coincides with a Treasury Department questionnaire asking dealers about the outlook for bond-market liquidity. Treasury officials say any additional program of asset purchases by the Fed won’t affect borrowing plans.

Treasury officials say they want to avoid any disruption to the $8.5 trillion market in U.S. government debt, the world’s most liquid, as the Fed weighs restarting purchases. The Treasury also doesn’t want to give any impression to investors, particularly those based overseas, that it might be coordinating with the Fed to finance the national debt.

“Treasury debt-management decisions are designed to deliver the lowest cost of borrowing over time and are entirely independent from monetary-policy decisions made by the Federal Reserve,” Mary Miller, assistant secretary for financial markets, said in an e-mail to Bloomberg News yesterday. Before joining the Treasury last year, Miller was head of global fixed-income portfolio management at T. Rowe Price Group Inc. in Baltimore.

Quarterly Meetings

The Treasury is scheduled to hold its quarterly meetings with bond dealers tomorrow, ahead of the department’s Nov. 3 refunding announcement.

The Treasury is watching for signs the Fed’s buying program might affect market operations. Fed purchases would take place as the Treasury reduces debt issuance, raising questions of whether the government would have to sell additional securities to avoid market disruptions.

“That’s certainly kind of a nuclear option for Treasury,” Stanley said. “They would always and everywhere like to avoid that.”

Extra debt sales have happened just twice in the past decade, with so-called snap reopenings of existing securities in the aftermath of the Sept. 11, 2001, terrorist attacks and at the height of the financial crisis, in October 2008. The Treasury acted to shore up market liquidity and prevent a trading freeze caused by shortages of highly sought securities.

Predictable Sales

The Treasury has put a premium on selling its debt in a regular and predictable fashion. Those efforts may be tested by the Fed’s purchase campaign, which would take place in the secondary market rather than at Treasury auctions.

The Fed’s purchases might run as high as $100 billion a month, some analysts say -- almost equaling the entire amount the government is likely to sell.

“If the Fed commits itself to buying back the bulk of the Treasury’s net new issuance through open-market purchases, it will have more than one hand tugging on the wheel of federal debt management policy,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Crandall said the frequency of note auctions, combined with low interest rates, “sharply increases the likelihood of accidental reopenings in the next phase of the rate cycle.”

The Fed is unlikely to buy up the entire supply of new securities, although it may adjust its internal guidelines of how much it can hold of any given issue. The Fed limits itself to owning no more than 35 percent of any specific security it holds in its System Open Market Account, or SOMA.

Pricing Distortions

“Our Treasury strategists point out it could also cause pricing distortions along the curve, if, for example, the Fed continues to target a 40 percent purchase concentration in the 6-10 year maturity bucket, as it has in its recent purchases,” analysts at JPMorgan Chase & Co., including Alex Roever, wrote in an Oct. 22 research report. The report predicts the Fed will buy about $250 billion a quarter during the easing campaign.

The central bank makes the securities in its portfolio available to dealers through its daily securities lending operation, making it unlikely that Fed purchases alone would lead to an acute shortage of a given issue.

For now, the Treasury is doing everything it can to show borrowing independence. The department is extending the average maturity of its debt and ramping up sales of 10-year and 30-year securities while cutting issuance of the medium-term securities the Fed is more likely to buy.

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