Analyzing the Fed's Second Operation

The Federal Reserve just announced a second open market operation designed to provide liquidity sufficient enough to bring the fed funds rate down to the Fed's target, 5.25%. The size of the operation was $16 billion.

Earlier in the day, the Fed announced that a repo operation added $19 billion to the banking system, the largest single operation since August 2003, an operation that was very successful in bringing the funds rate lower.

The funds rate was trading at 6% when the Fed announced its first operation at 8:13 a.m., and 20 minutes later the funds rate was trading at 5.375%. The funds rate traded at that level all morning except for a few minutes when it traded at 5.50%.

With the funds rate trading at a level low enough to indicate fairly stable conditions, there was no obvious need for additional action from the Fed. Moreover, commercial paper issuers were apparently able to obtain funding at normal levels, too.

Hence, both the fed funds and commercial paper markets were trading in ways that suggested that both banks and corporations were having very little difficulty obtaining short-term funding today. Nevertheless, the Fed added additional money.

The Fed's decision to conduct two operations can mean two things. Either there is a greater strain in the market than is evident today in the fed funds and commercial paper market, or the Fed simply wanted to assure that a surfeit of liquidity would exist in the financial system in order to help it to stabilize.

It seems best to rely on market prices in this environment and believe that the Fed's second action was meant to provide a surfeit of liquidity and was not a response to a problem that perhaps the Fed knows more about than the rest of us.

ALL TONY CRESCENZI BLOG ENTRIES | POST A COMMENT | READ COMMENTS  

---

Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.