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December 28, 1949.


Dear Sir:


As a matter in which you will be interested, there
is enclosed a copy of a strictly confidential memorandum
prepared by members of the Board1s staff with respect to
recent developments in the short-term Government securities
Very trQ-y yours,

S. R. Car].:
Federal Open Market Committee,

(with an extra copy marked for hr. Rouse)

December 23, 19A9-


Recent developments in the short-tern. Government securities
market merit special attention. For various reasons short-term rates rose
to and remained at levels which endangered a successful January refunding
at the 1 1/8 per cent coupon rate announced by the Secretary of the Treasury on November 30. The Treasury has shown concern over developments and
Mr. Haas called llr. Rouse on December 15 to inquire about possible System
operations in view of the refunding.


As a consequence of the danger to the Treasury financing program
inherent in the new rate structure, the S3rstem has during the last few days
engaged in vigorous operations in the bill and certificate markets to the
extent of lowering yields on these securities.
Pressure in the moneyraa.rketwas anticipated by the Executive
Committee of the FOMC at its meeting on November IS, and to some extent was
augmented by System action in permitting its maturing bills to be redeemed
at a time when the market was temporarily flush with funds. The pressure
on the :iarket, however, was somewhat greater than had been expected, partly
because of a more rapid credit expansion and consequent increase in required reserves, and partly because of uncertainty in the market resulting
from public discussions of System policy. Excess reserves of member banks
averaged only 650 million dollars over the week ending November 30. Yields
on short-term Government securities had risen by November 28 to a level
breaching at least technically, the 1 1/8 per cent rate on one-year securities.
In recognition of the announced refunding program, particularly
the 1 l/8 per cent certificates of January 1, the Systen held the shortterm rate from rising further by purchasing about 600 million dollars of
Government securities during the first two weeks of December. Excess reserves rose sharply the first 10 days of December and averaged over 900
million dollars during the following week.
Despite vigorous Systeii buying and the resulting expansion in
bank reserves, short-tern rates continued close to the System buying rates
over this period. This upward pressure on rates apparently reflected a
combination of factors: (1) bank deposit expansion increased required
reserves substantially while the seasonal currency demand absorbed reserves;
(2) it was expected that any fall in short-term rates would be short-lived
in view of an expected drain on bank reserves in the last half of December;
(3) testimony before Congress together with System operations around the
end of November, was taken to indicate a change in System policies; and
large dealer's positions in bills were overhanging the market.
At the close of trading on December 15, dealers marked up the
yields on bills from 1.11 to 1.12 per cent, threatening the 1 1/8 per cent,



1 year rate. This coincided with announcement of the opening of the books
for the January refunding.
In order to protect the refunding operation, particularly in view
of expected drains on bank reserve positions resulting largely from currency
outflows and Treasury quarterly income tax receipts, the System entered the
narket aggressively on December 15 and 16, purchasing bills and certificates
in large volume, primarily from dealer portfolios. Bill purchases on December 16 began at a rate of 1.11 per cent (longest issue), but subsequently
over the day purchases were made at successively lower yields. Purchases
of certificates by the Syste:.: followed a sinilar pattern. The longest bill
issue closed that day at 1.09 - 1.05 psr cent and the longest certificate at
1.10 - 1*08 per cent. Total purchases on December 16 were 229 million
dollars (including 70 million of the January certificates). On December 19
and 20, the System purchased 91 millions of bills and certificates (including 4.6 million of the January certificates) to hole1, short-term yields at
these levels.
Accompanying the decline in short-term yields, there has been a
renewed rise in long-term bond prices to the highest levels in more than
two years, although the narket continued snail in voluue.


Some questions and conclusions as to Syste..: policies and operations are suggested by these developments:

(1) Under the circumstances substantial purchases by
the System since December 15 have been essential
to assist the January refunding.
(2) It appears that the bidding down of yields through
aggressive buying was also necessary, but this
operation has aroused suggestions in the market that
the Syste.a has been engaged in deliberate "rigging"
operations. Despite the aggressive nature of the
Qystem operations, however, excess reserves declined
slightly over the week, and as a consequence this
type of talk has died down.
(3) Even with aggressive support by the Syste:i, the new
offering of 1 1/8 per cent certificates may draw a
heavy voluntary redemption of cash. Purchases by
the System of January certificates (a form of cash
redemption) have been rather lc.rge in past few days
and may need to continue in order to assure success
of the refunding because of the feeling in the market
that the rate may be too low in view of immediate
economic prospects and possible Federal Reserve
policies consistent with that situation.




(U) More fundamentally, question may be raised as to
the desirability of the System having to force down
yields in its market support operations under conditions of strong credit demands. If some rise in
rates could have been permitted, the necessary volume of System operations would probably have been
much less. The market would have made its own
adjustments to meet a partially temporary and a
partially longer-term change in the situation. As
it is now, the easing of the market which will follow in January, unless offset by System operations,
will be much greater because of Systen purchases in
December to peg the certificate rate at a level that
appears to be too low under prospective conditions,
(5) The renewed rise in bond prices gives support to
the view thc.t maintenance of short-term yields at
present low levels is likely to lead to further
declines in long-term rates,



(6) These various developments have been in line with
the Executive Committee‚ÄĘs earlier judgment, although
somewhat more severe.