Tuesday, December 08, 2009

A less modest proposal

The Fed is test-driving a reverse repo scheme with primary bond dealers to drain liquidity from the banking system. Frankly, I don't entirely get it: the Fed sells securities to the dealers, taking money out of the system for a spell, and then buys them back at the end of a set period. They're practicing now, did $180 mln in volume in recent days. I guess it would work if they did it once and kept doing it, so that cash stayed out of the system. But that would get expensive just from a process standpoint.

My proposal is: sell treasury and agency (Fannie and Freddy) debt back into the market via the Fed Open Markets desk. When the Fed receives cash, it hits the delete button and "poof", it's gone. Like Kaiser Soze.

Right now is not the time to do this. The housing markets are still too unstable. Shit, I'm too unstable. But there will come a time when it makes sense to, gradually, in a pre-announced fashion, sell down it's portfolio. Yes, it will have the effect of gradually raising interest rates, but to the extent that it excites confidence in our fixed income markets and, more importantly, the somewhat wilted greenback, it might attract capital. Remember how all those fed funds hikes from 2003ff didn't really cause mortgage rates to skyrocket? Emerging market treasuries liked the dollar. They still want to, they're just confused is all.


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