Fed Extends Reverse Repo Program for Year to Aid Eventual Exit

Federal Reserve policy makers extended for a year tests of an overnight fixed-rate reverse repurchase program that could serve as an additional tool for the Fed when it eventually seeks to raise interest rates.

“This work is a matter of prudent advance planning,” the Federal Reserve Bank of New York, the branch of the central bank that implements monetary policy, said today in a statement on its website. The tests will be extended through Jan. 30, 2015.

Starting tomorrow, “ the maximum allotment cap will be increased to $5 billion per counterparty per day from its current level of $3 billion,” and may be increased further, the New York Fed said.

The Fed, which is buying bonds to support the economy, has been testing the repo program as part of its preparations to eventually withdraw record accommodation. In a reverse repo, the Fed lends securities for a set period, temporarily draining cash from the banking system. At maturity, the securities are returned to the Fed, and the cash to its counterparties.

Simon Potter, the New York Fed’s markets group chief, said on Dec. 2 the new repo tool will probably play a central role in tightening monetary policy.

Market “participants have indicated that they expect that a facility, if executed in full scale in the future, should be an effective tool for increasing the Federal Reserve’s control of short-term money market rates,” Potter said in a Dec. 2 speech in New York.

“Operationally, market participants generally characterize the exercise as smooth, with minimal disruptions,” he said.