FED COMPLETES FINAL SALE OF YEAR-END REPO OPTIONS; Y2K LOOMS
By Ellen Taylor
NEW YORK (MktNews) - The Federal Reserve Bank of New York completed its final sale of year-end options on repurchase agreements Wednesday, selling $54.95 billion in backup funds to dealers who may -- or may not -- need extra financing money at the end of this month.
Wednesday's sale was about the same amount as a week ago and brings the total "as needed" repos sold to dealers this fall to about $481 billion. The Fed has added extra grease to the market's Y2K wheels by adding about $36 billion in long-term repos that mature in January. It launched both programs in October to alleviate financing problems over the turn in the calendar to 2000.
There are concerns that some older computers could malfunction because they were programmed to recognize only the final two digits of the year. That could make systems shut down when the century changes to 2000 from 1999 on Jan. 1, potentially creating disruptions in the financial markets.
In the final auction today, the premium paid on the coveted Dec. 30 strip was 2 basis points, half of last week's 4 basis points. The highest fee paid by dealers to be assured of having enough cash over the New Year's weekend was 16 basis points in the Nov. 3 auction. The Fed has held seven weekly options auctions since Oct. 20.
Dealers paid 0.5 basis point to have the ability to borrow money on one of each day between Dec. 23 and Dec. 30 and 4 basis points for the final package, spanning Jan. 6 to 13. Fees paid for those dates topped out at 11 and 11.5 basis points, respectively, again in the Nov. 3 auction.
The options guarantee dealers backup financing via overnight repos on any or all of the five business days beginning on December 23, December 30 and January 6. If dealers decide to exercise the options, they must do so by 10 a.m. New York time on the strike date. The financing will cost them 150 basis points above the Fed's target rate for federal funds that day, plus the premium set in the auctions.
On Dec. 30, dealers may choose either to exercise the options by 10 a.m. EST at 150 basis points or as late as 11:30 a.m. paying 250 basis points over the funds target, with the auction premium added on top of that rate. Bond dealers have to pay the premiums whether or not they decide to use the options later this month or on Jan. 6.
Demand has been greatest for the Dec. 30 to Jan. 6 period since that's the only package that covers the New Year's weekend when Y2K-related credit problems are expected to be greatest. Accordingly, the Fed raised the amount of the Dec. 30 strip to a high of $50 billion, far above the $6 billion the Fed originally said it would auction when it announced its Y2K reserve measures on Sept. 8. Today's is the first among the seven auctions that dealers paid less to borrow money on Dec. 30 than on either Dec. 23 or Jan. 6.
The Fed also said it would accept a broader array of collateral on repos done between October and April on Sept. 8, accepting more types of agency and mortgage-backed securities as backing on the transactions.
With the funds target expected to remain at 5 1/2 percent through the end of the year, money would cost as much as 7.16-8.16 percent if dealers exercise the options.
Without question, there is a lot of confusion about just how high interest rates will rise on Dec. 31, spurred by Y2K fears. Funds rates are notoriously volatile every year on Dec. 31 and Y2K is likely to make them roller coaster even more than in recent years, analysts say. Fed funds over the New Year's weekend currently are trading at about 9.50 percent, but general repo rates are much lower at about 5.875 percent.
Part of that disparity can be attributed to the collateral behind each transaction since the repo rate is good for transactions backed by ultra-safe Treasuries. traders said. At least 50 percent of the collateral taken by the Fed on its longer repos has been federal agencies and mortgage securities as dealers have dumped the less creditworthy collateral to be assured they can finance it over year end, traders added.
Federal funds, on the other hand, are unsecured sales of overnight money between banks. And since funds traders are risk takers just like other traders, they are willing to sell money at the higher rates if they think the Y2K concerns are overblown. If the reality on Dec. 31 supports that bet -- and many analysts think the Fed's hefty reserve additions over the century change will cap rates below 7 percent on Dec. 31 -- funds traders will be able to buy back funds well below 9.50 percent and lock in a hefty profit, traders said.
The Fed has left the door open for possibly letting dealers send back some of the excess cash they could end up with if they exercise the options but then later decide they don't need the funds or if funds rates are lower than 7 percent on Dec. 31. That would take the form of overnight matched sales, or reverse repos, in which the Fed sends back some of the collateral they took on the repos against a payment of cash, thereby draining the excess reserves from the banking system.
Peter Fisher, an executive vice president at the New York Fed who oversees the bank's open market operations, is the Fed's main operational point man entrusted with making sure that year-end credit problems don't get out of control. "We see potential strains in the financing markets at year end and we want to mitigate the risks there will be a flight to quality," Fisher said at the Sept. 8 press conference when he unveiled the Fed's Y2K-busting agenda. "We face uncertainty here. We've never been through a Y2K before." etaylor@marketnews.com. |
