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Authorized for public release by the FOMC Secretariat on 2/3/2021 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON, D.C. 20551 May 14, 1975 CONFIDENTIAL (FR) CLASS II FOMC TO: Federal Open Market Committee FROM: Arthur L. Broida Attached is a memorandum from the staff dated May 13, 1975, and entitled "Foreign Account Repurchase Agreements Handled by the Trading Desk." This memorandum, which was prepared in response to a recent question about Desk accommodation of foreign account RP's, is being distributed for the information of the Committee. desired, it could be listed for discussion on the agenda future meeting of the Committee. Attachment If for a Authorized for public release by the FOMC Secretariat on 2/3/2021 CONFIDENTIAL (FR) CLASS II FOMC DATE: TO: Federal Open Market Committee FROM: Staff¹ SUBJECT: May 13, 1975 Foreign Account Repurchase Agreements Handled by the Trading Desk. Since August 1974, the Federal Reserve Open Market Trading Desk has been regularly arranging repurchase agreements (RPs) for foreign central bank correspondents. This facility was originally offered to the accounts as a means of temporarily investing large acquisitions of dollars, particularly by oil-producing countries, until longer-term placement of the funds could be accomplished. It was visualized that in the case of large receipts of funds within a short period of time, in some cases by countries not previously accustomed to handling large flows, there could be times when Treasury bills or other securities desired by the foreign accounts might not be available in sufficiently large supply. Also, in some cases, the foreign investor might need time to decide where it wanted to place its funds. In these circumstances, it was believed that RPs could provide a temporary investment while awaiting the availability of securities that the accounts would be willing to hold on a more permanent basis, or awaiting the decision-making process by the foreign investors. Another reason for offering a repurchase agreement facility was to provide a reasonably attractive domestic alternative to temporary investments in the Eurodollar market and thus enhance foreign official interest in ¹ This memorandum was prepared mainly by Mr. Cooper of the Federal Reserve Bank of New York. It has been reviewed by Messrs. Holmes, Sternlight, and Axilrod, who concur in the analysis. Authorized for public release by the FOMC Secretariat on 2/3/2021 direct U.S. dollar investments. This form of investment, it should be noted, is a common one in the money markets employed by many market participants at least since the 1950's. Within a short period of time, the RP proved itself to be a very useful instrument for the purposes outlined above. A number of accounts used them from time to time, rolling over maturing agreements for a succession of several days, or occasionally making arrangements that lasted up to a maturity as long as 15 days, while endeavoring to determine and accomplish their longer-term investment programs. Some accounts used it at times when they could not commit funds more permanently because of uncertainty as to the timing of prospective outpayments. In one particular case involving an oil producer, there was considerable uncertainty as to the kind of longer-term investment program that would best suit its needs. That account leaned heavily on the RP for an extended period of time, but has since cut back its use of the instrument in response to our urging. About 17 accounts have used the RP at one time or another since it was made available. Over the period of nine months through April 1975, RPs were arranged by the Desk for foreign accounts on just about every business day in amounts generally ranging from around $60 million to nearly $1.5 billion, which was also the largest total outstanding on any day (April 16, 1975). A considerable portion of the RPs were only overnight, so that the rolling over of maturing agreements contributed significantly to the daily volume of new contracts. (A daily tabulation of foreign RPs and System trans- actions in the market through RPs and matched sale-purchase agreements is attached). Authorized for public release by the FOMC Secretariat on 2/3/2021 From the beginning, the foreign RPs were meshed with System open market operations whenever it was considered appropriate in achieving the reserve and/or money market objectives of the Desk. Thus, over the nine months (185 business days), RPs were arranged in the market on behalf of foreign accounts on only 49 days when there was no related System action either in the market or directly with the foreign accounts. On the remaining days, the Desk also took some action to affect reserves. These related transactions usually took the following forms: 1. On 33 days the Desk crossed the foreign RPs with the System Account through System matched sale-purchase transactions, while taking no related action in the market to affect reserves. This provided the Desk with a means of absorbing reserves unobtrusively when it was either unnecessary or considered undesirable for some reason to take overt action in the market. These operations had the same result as outright System sales to foreign accounts except that the effect on reserves was temporary, usually just overnight or over a weekend. On another six days, the Desk only crossed part of the foreign RPs with the System Account, thereby reducing the amount of foreign RPs done in the market, when it appeared desirable to do so from the System's standpoint. 2. On 38 days, the Desk did matched sale-purchase transactions with the foreign accounts and also arranged System matched sale-purchase transactions in the market on its own behalf. On those days, the Desk's absorption of reserves in the market was reinforced by its transactions with the foreign accounts. Alternatively, one might say that the size of the market action required to achieve the Desk's reserve objectives was reduced by the opportunity to absorb the foreign account funds. 3. On 15 occasions, the Desk undertook to arrange RPs in the market for both foreign accounts and on behalf of the System on the same day, thereby investing the foreign account funds and responding to reserve needs in separate market actions that were independent of each other. This course of action proved to be rather complicated, however, because of different ground rules applicable to the System and foreign account repurchase agreements, mainly with respect Authorized for public release by the FOMC Secretariat on 2/3/2021 to the type of collateral that is acceptable, rights of termination before maturity, and the method of calculating margin and proceeds. It was considered awkward and unnecessarily confusing to the market for the System to approach dealers for RP propositions with one set of ground rules for its own account and different ground rules for its customer accounts. 4. In view of the foregoing considerations, the Desk undertook on 43 occasions to arrange matched sale-purchase transactions with foreign accounts while on the same day executing System RPs in the market in sufficient volume to offset the impact of the matched agreements and also inject the desired net amount of reserves into the banking system. This was accomplished by simply increasing the amount of System RPs in the market by the amount of matched agreements arranged with foreign accounts, so that the difference between the System's RPs in the market and the matched transactions with the foreign accounts provided the injection of reserves deemed appropriate for that day. On those occasions, described in paragraph 3 above, when the Desk undertook both types of RPs in the market on the same day, it was generally because the timing of foreign RP orders and Desk decisions to provide System credit to the market did not permit the coordinated approach described in paragraph 4. Thus it sometimes happened that foreign RPs were executed in the market at a time when it appeared that no System action was called for; then late in that same day, a tightening money market may have caused the Desk to arrange System RPs in order to inject more reserves. Alternatively, the Desk sometimes arranged System RPs early in the day, before it was known that there would be sizable foreign RPs requested; when the foreign requests were received, it was considered preferable to execute them in the market rather than cause the reserve absorption that would result from arranging matched transactions with the System. Authorized for public release by the FOMC Secretariat on 2/3/2021 In providing the RP facility to the foreign accounts, the Desk and related functions of the Reserve Bank anticipated that there would be an increase in the volume of transactions that had to be handled. However, some part of the increase would presumably have occurred anyway, since part of the foreign-held dollars would undoubtedly have been invested through the Desk (in Treasury bills or bankers' acceptances), even if the RPs had not been made available. So far, the Desk has been able to handle the increased business with few problems although some strains were apparent during relatively short periods of peak activity in November and February. Meanwhile, this Bank has urged at least one foreign account to place its funds on a more permanent basis. Market forces have also worked in this direc- tion to some extent by narrowing the spread between RP rates and those on Treasury bills and other short-term money market instruments. There are certain advantages to the System in arranging shortterm RPs for the foreign accounts. It enables the System to keep track of large and volatile flows of funds that would be unknown or obscure at best if they were channeled by the foreign accounts through outside agents. More importantly, the Desk has the opportunity to coordinate the foreign flows of funds and its own operations with a view to achieving monetary policy objectives within the context of maximum efficiency in the money market. When a foreign RP is made directly in the market, dealers are informed that the transaction is for customer account. While the market is not informed about each occasion when the Desk undertakes Authorized for public release by the FOMC Secretariat on 2/3/2021 matched agreements with foreign accounts, market participants are well aware that this is always a possibility--just as they realize that the Desk may be arranging outright purchases or sales of securities with foreign accounts. Consideration has been given to informing the dealers, when relevant, that a particular amount of the System RPs with the market are being undertaken merely to offset System matched agreements with foreign accounts, but this has not been done up to this point, as there did not appear to be sufficient reason to identify for the dealers one particular factor absorbing reserves--since the System's decision to make RPs could just as well reflect a variety of factors such as a temporary build-up in Treasury balances. As noted, the market is aware that the System always has the option of making RP-type transactions directly with foreign account. Thus, if the foreign RP is made in the market (either directly or indirectly), there is some possibility that dealers will attempt to interpret the transaction as another clue to the lower bound on the Federal funds rate (since instead of making foreign RPs in the market, the Desk could have absorbed reserves by making a matched sale-purchase transaction with the foreign account). Such market reactions have not, however, unduly complicated monetary policy operations, and in any event are no different from possible market reactions to outright U.S. Government security transactions with foreign account. A possible disadvantage to the Desk in handling the foreign account RPs could occur at times when there is a general shortage of collateral such as existed at times in 1973 and 1974. Under those Authorized for public release by the FOMC Secretariat on 2/3/2021 conditions, the placement of large amounts of foreign account funds in RPs could immobilize collateral that might otherwise be available to the Desk for purposes of making RPs for the System and thus inhibit the Desk in its efforts to achieve reserve and money market objectives. Upon examination, however, it seems likely that in the absence of opportunities to do RPs, the foreign account funds would be invested more permanently on an outright basis, thereby immobilizing potential collateral for even longer periods of time. Moreover, given the pro- spective deficits and huge borrowing needs of the Treasury over the next couple of years, it is unlikely, at least in the near term, that there will be any shortage of securities eligible to serve as collateral for either System or foreign account RPs. There are certain risks, however, in an excessively large volume of foreign RP funds. For one, an undue amount of the time and resources of the Trading Desk staff could be absorbed in managing these transactions. For another, these funds can be highly volatile, and there could be short-run disturbances in the financing of the dealer market should foreign sources become large lenders to dealers and the market thereby become dependent on these sources. Foreign central banks do not, in the nature of the case, have the longer-run interest in stable relationships with the dealer market that many U.S. commercial banks and corporations have; and they may be more likely to withdraw funds without regard to the needs of the domestic money market and irrespective of interest earnings. Thus, the staff believes that efforts should continue to be made by the Federal Reserve Bank of New York to encourage Authorized for public release by the FOMC Secretariat on 2/3/2021 foreign central banks to invest dollar holdings on a more permanent, longer-run basis rather than through the RP route. SUMMARY AND CONCLUSIONS The opportunity to invest short-term dollar holdings in RPs was offered to foreign accounts in 1974 for specific purposes and was quickly recognized as a useful medium for temporary placement of funds at times when longer-term commitments could not be undertaken for one reason or another. Despite the increased burden of handling the transactions, the Desk and related areas of the Bank have not encountered any great administrative problems. Neither has the use of the facility interfered noticeably with the achievement of the System's reserve or money market objectives. Advantages to the foreign accounts are greater flexibility in handling their short-term dollar holdings and the ability to avoid the risk of price fluctuations while working on longer-range investment programs. Advantages to the System are the ability to keep track of huge flows of funds passing through the money market more accurately and the opportunity to offset or mitigage their effect on the money market when it suits the Desk to do so. From the standpoint of general market stability, the investment of the funds in RPs is probably less unsettling than outright purchases of securities and subsequent sales would be. One potential disadvantage to the System, that of competition for available collateral, is more apparent than real, given the prospective supply conditions over the next several years. If shortages of collateral again develop, the Desk would, of course, have to reassess the priorities of the System and the foreign accounts. If foreign RPs were to become Authorized for public release by the FOMC Secretariat on 2/3/2021 very large, other disadvantages would include undue absorption of Trading Desk resources and the potentiality of excessive dependence of the dealer market on volatile foreign sources of funds. It appears, on balance, that foreign account RPs, in the magnitude handled so far, have posed no real problems for the Trading Desk and the market, and that the advantages of continuing relationships with foreign accounts and knowledge of foreign flows have outweighed the thus far minor disadvantages of RP transactions. However, in order to guard against excessive foreign activity in the RP market and undue complications in monetary policy operations, the Federal Reserve Bank of New York is continuing to encourage foreign accounts to employ their dollar holdings on a more permanent basis. Should there be increased demand for RP investments by foreign account, the Bank would be prepared to intensify its efforts in this direction in order to keep such activity to manageable levels. Authorized for public release by the FOMC Secretariat on 2/3/2021 System Open Market Account Matched Sale-Purchase Transactions and Foreign Accounts Repurchase Agreements (In thousands of dollars) Commit. Date -1974Aug. 5 Foreign Account RPs In With Market System 7 12 13 401,400 100,200 100,100 670,000 300,100 20 21 22 85,000 100,000 100,000 104,375 400,100 23 64,400 26 60,000 510,200 1,075,460 60,175 1,670,000 28 60,145 2,866,000 361,600 100,405 2,095,325 6,966,000 29 30 Sept.3 4 5 6 9 10 11 12 1,213,975 100,000 120,000 400,000 25,000 13 16 17 19 20 23 24 25 26 27 30 100,440 100,465 100,445 100,410 75,235 3,270,590 1,705,630 1,270,000 100,200 266,665 320,925 610,475 1,326,700 805,882 472,295 615,685 18 Tot. 489,380 450,450 745,100 27 Aug. RPs for FRBNY 1,760,000 361,400 99,900 8 9 Tot. Matched the Market 450,000 6 14 15 16 19 System Transactions in 1,990,000 1,710,500 467,630 427,797 1,072,695 165,000 213,885 612,500 358,000 605,900 225,730 419,831 Sept. 3,289,140 3,837,320 5,583,000 4,710,925 Authorized for public release by the FOMC Secretariat on 2/3/2021 con't Foreign Accounts RPs In With Market System Commit. Date -1974Oct. 1 System Transactions in the Mark Matched 281,625 893,900 148,640 435,000 149,480 68,165 122,270 148,535 63,215 117,390 RPs for FRBN 417,550 832,600 3,200,000 2,046,000 1,020,000 580,000 4,000 2,196,400 1,557,500 625,335 280,000 233,795 280,720 70,060 1,200,000 819,000 105,000 25 28 29 30 31 Tot. Oct. Nov. 58,000 187,000 58,000 918,000 2,324,245 10,250,000 1,507,640 1 197,665 4 250,335 202,070 222,800 388,495 314,505 7 8 12 13 14 67,000 255,220 6,799,650 885,300 1,339,700 1,455,000 327,700 214,545 15 18 19 1,145,555 1,095,365 20 21 22 1,106,500 1,005,800 762,600 783,300 1,103,980 25 26 27 29 Nov. 901,700 232,000 6 Tot. 105,435 58,220 4,680,920 833,060 208,460 209,270 325,055 4,725,460 700,000 2,155,000 2,113,800 1,194,555 1,572,100 1,237,650 9,889,005 Authorized for public release by the FOMC Secretariat on 2/3/2021 Commit. Date -1974Dec. 2 3 4 5 6 9 10 11 12 13 16 17 18 19 20 23 26 27 30 31 Total Dec. -1975Jan. 2 3 6 7 8 9 10 13 14 15 16 17 20 21 22 23 24 27 28 29 30 31 Total Jan. Foreign Account RPs In With Market System 200,000 224,055 188,12.0 451,885 312,910 System Transactions in the Market Matched RPs for FRBNY 1,521,200 3,107,000 312,000 325,500 127,210 127,240 2,327,020 1,054,510 409,870 1,418,400 85,900 387,900 409,400 411,350 1,399,900 881,580 1,577,950 2,777,800 441,735 325,255 2,132,050 323,850 215,445 118,275 287,208 4,607,568 843,380 2,191,900 1,100,580 1,140,250 4,247,250 182,100 16,039,710 1,764,380 468,800 74,785 168,500 84,150 87,420 64,575 925,000 2,116,000 1,155,000 130,300 193,500 454,250 205,870 130,700 630,855 272,015 683,000 631,590 60,595 348,575 348,705 2,416,050 1,836,815 530,155 333,540 346,490 2,256,005 894,700 343,500 331,000 357,000 1,795,815 297,690 4,357,795 4,879,000 1,057,400 11,148,400 Authorized for public release by the FOMC Secretariat on 2/3/2021 -4Foreign Account RPs System Transactions in Commit. Date In Market With System Matched Feb. 204,800 192,095 195,425 198,335 222,190 1,232,000 1,265,000 680,000 3 4 5 6 7 10 11 13 14 18 19 20 21 24 25 26 27 28 Total Feb. Mar. 3 4 5 6 7 10 11 12 13 14 17 18 19 20 21 24 25 26 27 31 Total Mar. the Market RPs for FRBNY 1,123,400 218,500 1,083,960 2,413,250 798,555 1,372,250 558,060 1,945,200 484,820 2,764,800 224,835 242,500 1,276,875 717,500 708,400 499,900 490,700 517,640 4,876,815 830,145 3,989,865 3,177 000 2,264,400 12,681,855 2,286,300 856,180 840,800 219,795 441,580 272,670 262,580 163,870 142,140 234,930 235,310 238,510 239,665 239,560 1,480,000 1,565,000 1,500,000 2,815,000 1,445,000 1,125,000 514,000 790,000 478,000 141,400 160,400 180,760 2,727,500 2,727,500 345,590 147,765 869,350 361,500 229,800 298,700 2,032,600 4,220,905 11,712,000 5,883,150 Authorized for public release by the FOMC Secretariat on 2/3/2021 Commit. Date Foreign Account RPs In Market SOMA Apr. 234,700 1 2 3 4 7M 8 9 10 11 14M 15 16 17 18 21 22 23 24 25 28M 29 30 Total Apr. May 1 2 5 6 266,915 226,875 92,370 157,300 Matched RPs for FRBNY 2,140,000 - 182,035 517,895 1,396,745 132,310 398,000 1,345,300 SOMA Transactions in the Market 675,000 1,315,000 1,270,000 - 1,459,125 958,790 2,825,800 1,766,100 505,050 271,950 258,500 334,135 1,305,000 213,105 2,442,575 1,688,800 1,587,660 14,861,285 537,300 884,300 2,361,050 317,500 181,200 3,171,300 159,270 6,975,070 108,095 105,190 5,400,000 2,018,900 1,002,100 102,700 97,630 179,975 123,500 709,500 1,984,060
@FedFRASER