Peter Fisher

During the second maintenance period, it was widely assumed that the intermeeting announcement of lower rates at 3:15 p.m. on October 15 reflected an abrupt action to deal with one or two troubled institutions. This then caused an extreme level of discount window aversion over the subsequent days, particularly as you can see in the chart on October 16, 19, 20, and 21. We faced a trading range that was consistently above the target, the blue line, during the morning on those days as banks held on to as many reserves as they could to avoid late day surprises and the risk that they might have an overdraft on their reserve account.

In managing the quantity of reserves in the banking system to achieve the FOMC’s objective of having the Fed funds rate trade, on average, around the target rate—now at 5.50 percent—we are adding or draining reserves to keep supply and demand in the Fed funds market in balance. In doing this, however, we do not seek to achieve an "average" rate around the target by consciously offsetting deviations from target on previous days.

If the rate is high on a Monday, we do not seek to create a low rate on Tuesday in order to "average" around the Committee’s target. Rather, we strive to guide the funds rate on a path toward the target over all of the remaining days of each two-week maintenance period, and to let bygones be bygones with respect to higher or lower rates on previous days.

In July the Federal Reserve announced the creation of a special Y2K facility for liquidity for the fourth and first quarters: the Special Liquidity Facility—or SLF—which began operations in October. The SLF is designed to help banks manage their balance sheets flexibly in the face of risks of large deposit drawdowns to meet demand for currency or deposit transfers. The terms of SLF lending are also designed to provide the funds market more broadly with an alternative source of liquidity for meeting daily clearing and settlement, albeit one that comes at a premium of 150 basis points over the Fed Funds target rate. However, the impact of this facility in shaping expectations about the availability of year-end liquidity in the money markets appeared to be hampered during the summer by banks’ unwillingness to commit themselves to extend its benefits to their customers.

Bernanke had emerged from the June 19 meeting to say the central bank expects to reduce the pace of purchases later this year and to halt the program altogether midway through next year, when unemployment is around 7 percent, as long as the economy improves as expected.

He also sketched out the Fed's expectations for keeping rates low in the years ahead and for the even longer-term plan for shrinking the central bank's $3.4 trillion balance sheet.

"Well, that's three different parts of forward guidance," said Peter Fisher, senior director of the BlackRock Investment Institute. "I've been in this business a long time, and bond market guys aren't that clever. We can't price all that in."

As reported by Reuters.