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Draft 8/13/52
ASTES
Market stabilization - A u g u s t -September financing.
(a)
Stabilization operations must be in accord with policy
adopted by Executive Committee of Federal Open Market
Committee at its meeting July 22, 1952.
"To effect a controlled release of reserve funds through
open market operations while, at the same time, attempting
to force the m e m b e r banks to increase their dependence on
the discount window in meeting their reserve needs." * * *
"Making purchases of short term Government securities
which could later be sold or allowed to run off if the situation
warranted." * * * "In view of the relatively small size of
this refunding (August 15 -September 1), the System might
advantageously experiment in its open market operations
by making purchases of Treasury bills and short term
ertificates rather than concentrating all of its stabilization
operations in 'rights' and 'when issued' securities." (Not to
maintain a premium on rights) * * * "At one time the guide
(to policy) might be interest rates and at another m e m b e r
bank borrowing; that during the actual refunding of the
Treasury's maturing certificates, there should be reasonable
stability in market rates. Once that operation is completed,
however, the System might contemplate a further rise in
m e m b e r bank borrowing of say $500 million and a further
firming of money rates. " * * * "Try to moderate movements
but not attempt to hold rates after the forthcoming refunding operations
were out of the way. " * * * "the October refunding should be determined
in the light of conditions at the time."
After conversations Chairman and Secretary of Treasury, the word was
that Secretary was accepting our suggestion (2% for not more than one
year), in light of our credit policy, and we should "lean over backward"
in helping make issue a success. Success initially is measured in terms
of attrition. (Attrition - Treasury $
or
%.
Federal
Reserve Banks bought $180.4 million "rights" and sold, on swaps, $170.5
million certificates - October, February, June)
Market was supported - stabilized - fromtime of Treasury's announcement
of financing on July 30th to closing of the books on August 7th, by
^purchases of bills, certificates and bonds (2% bonds of 1953), and by
swaps of other securities (mostly October certificates) for "rights".
Taking account of all System purchases the total gross support given
the market was about $430 million.
Net of swap sales and dealers sales
contracts about $325 million of reserves were supplied to the banks by
open m a r .et operations.
Funds were furnished freely to dealers to
enable them to carry short term positions without loss; they reduced
their sales contracts as funds became available to the market. Similarly
m e m b e r banks reduced their borrowing through the discount window by
about $650 million (from about $1,400 million to $750 million). There
was no attempt to maintain a premium - rights value - on the maturing
issues, which were bought at net par to the seller (100 plus $75 commission)
on outright transactions, and on swaps at 100 l/64 net and interest.
Only argument (and that among ourselves) seems to have been whether
we should engage in swaps for "rights" or only buy the maturing
-3 -
obiigations and let the market seek to fill the other side of the
transaction, thus forcing up prices and forcing down yields
in this area. (October certificates involved in swap trans
actions were sold at 1.81% to 1.82%.)
\
l\
This in turn involved a judgment as to whether the market would
function in this way.
There was the real possibility that the
holder of maturing issues (or dealer Acting for him) not finding
a convenient and ready swap, would hold the August and September
certificates and cash them at maturity, before making other
investments. In the interest of promoting As large an exchange
\\
as possible ("leaning over b a c k w a r d ”) to facilitate an offering
which w a s not being well received, it w a s decided to help out
on swaps if they were preferred by the market.
ready to buy outright or on swaps.)
(We were
This also m a y be claimed
to have had the effect of helping the financing with a smaller
net use of Federal Reserve funds than would otherwise have
been possible.
In view 01 the fact that the banking position w a s
being eased considerably by our operations and other factors
(in excess of what w e would have wanted to do at this time
in the absence of Treasury financing), this consideration wa s
not without weight.
O n the other side, it w a s urged that, at
best, w e w ere only pushing over to October 1st the problem
w e were relieving on August 15th, by m a k i n g these swaps, and
at worst it might involve putting m o r e m o n e y into the mark e t
rather than less.
There is no final settlement date in these
matters, however, and if the changing needs of investors
are met by pushing forward redemption dates, it
can be a continuing process of market adjustment,
which should require less rather than more reserve
funds.
When the books closed Thursday, August 7th, we con
sidered the possibility of continuing our stabilization
operations through the following week to the payment date,
August 15th. The considerations were the fact that an
issue which goes to a discount as soon as the books are closed
and before payment date is less than a success, the market
was quite bearish on the course of interest rates, and the
October 1st financing loomed ahead. If the bearishness of
the market was exaggerated, and if the use of a small amount
of reserve funds could help to reduce this exaggerated bearish
ness, it might be constructive both in terms of credit policy
and debt management.
Otherwise the Treasury might be forced
to place a higher coupon on its October financing than the real
facts justified (that is higher than say 2 l/8% for one year),
or we might be forced to put more funds into the market then,
to support a closely priced issue, than we would have to put
in now to give a little further help to the current financing.
It has to be kept in mind that we are going to have to provide
a large amount of reserves to the m e m b e r banks during the
remainder of the year, some of it through open market
operations in line with the policy adopted by the Executive
Committee.
-5-
Purchases during the week beginning August 8 and ending
August 15 would have consisted primarily of the "when issued"
securities, which would have meant paying at least net parto
the seller, either outright or through swaps.
On the other side it was urged that this would be getting
back into the business of pegging prices, that it would mislead
the market as to rates, perhaps lead to a mistake in pricing the
October 1st refunding by the Treasury; and that it would provide
the banks with additional reserves at a time when we had already
relieved the pressure on their reserve position more than was
consistent with System credit policy at this time.
It is dangerous to be dogmatic about these things. The
more you are sure you are right the more you are likely to be
wrong.
There was no question of returning to a pegged market.
The only question was whether the market should be stabilized
-support of the new
(including/issue) for another week - until payment date - or not.
The market can be misled as to the future course of rates by lack
of knowledge of our intention to help meet seasonal credit needs anil
this can exaggerate market bearishness (perhaps it has alraady done
so).
The Treasury can price its October refunding "on the market"
instead of "on the rich side", and leave us with a difficult stabilization
job, no matter what we do now.
(If it does so, we can't repeat the
actions of September-October 1950.)
It is true that the banking position was relieved somewhat by
our open market operations, which supplemented other factors, during
the week ending August 6th.
-6G a in s fro m
Gold - Currency - Reserve Requirements
Treasury - Float - Other
Net open market purchases
*90
<
*>309
*133 (on a cpmmitment basis this
<■532
would.be *>208)
This enabled the m e m b e r banks to reduce their borrowings from) the Federal
Reserve Banks from 1,403 million to 843 million, a decline of
million.
(I
'\ \
Excess reserves of the m e m b e r banks moved from 637 million to\&09 million.
These are statistics. They don't tell the whole story. The hopes and
fears of the market enter in, as do our intentions. No one can say, I suggest,
that an additional 25 or 50 million of Federal Reserve net purchases of the
"when issued" August 15th certificates would have changed this picture
materially.
Yet that is all that might have been needed (there was little
reason to believe that many holders of "when issued" certificates, having
passed up their chance to swap or redeem, would now rush to sell at par),
if we were dealing with exaggerated bearishness in the market, or with price
markdowns on a limited volume of sales, in order to do a constructive job.
As it turned out the market was very quiet during the week preceding
payment date, and while the new certificates were bid at a discount (2.02)
little business was done. At the end of the week there were reports of
transactions at par. It m a y be that if we had shown a willingness to buy at
par, or better, a considerable amount of certificates would have been thrown
at us (the dealers tried us out with offerings when the market opened Monday,
August 11), or it m a y be that the reassurance of our buying would have
contented possible sellers, the quotation would not have gone to a discount
before payment date, and our purchases would have been negligible.
W e were taking a risk.
demands
Discussion in the market of private and public
for credit during the fall, and of our policy which was looked upon as
a "tight money" policy, and of the effect of monetary measures on
Government security prices abroad, particularly in Great Britain,
had led to fears of substantial increases in interest rates and sub
stantial declines in security prices. At least temporarily, the morale
of the market was distinctly low .
@FedFRASER