By Jonnelle Marte
NEW YORK (Reuters) - Boston Federal Reserve President Eric Rosengren on Tuesday said his preference for mitigating volatility in money markets would be for the central bank to continue to maintain its bond portfolio at a sufficient size, as opposed to relaxing bank capital requirements.
In an interview with Reuters before delivering remarks in New York, Rosengren said: "I would not be inclined to address it by regulatory changes. I would be inclined to make sure we maintain a balance sheet that's big enough that there's plenty of liquidity in the market."
The Fed began injecting liquidity into the overnight borrowing markets for cash in mid-September, when a shortage of reserves caused borrowing rates to spike above the Fed's target range. The U.S. central bank is also purchasing $60 billion a month in short-term Treasury bills in an effort to increase the balance sheet and add more reserves to the banking system.
Rosengren said Fed officials are working to increase the balance sheet to a level where the central bank does not need to conduct daily operations in the market for repurchase agreements, or repos.
Earlier on Tuesday, Dallas Federal Reserve Bank President Robert Kaplan said he supported re-examining liquidity regulations to help reduce the risk of volatility in money markets. Specifically, Kaplan said it would be "healthy" to look at how banks treat Treasury securities versus reserves when meeting stress testing requirements.
Rosengren said there are multiple variables that affect banks' decisions on whether to hold Treasury securities versus reserves to meet regulatory requirements, including Treasury issuance and the time of year, and that adjusting those rules could be complicated.
Some analysts say they are concerned that money markets could flare up again at the end of the year, when large banks are expected to cut back on repo lending to avoid higher capital surcharges.
Rosengren said the central bank is providing a lot of liquidity to help money markets get through the year-end period smoothly.
"I'm not sure exactly what will happen at the end of the year, but I think we've taken the right precautions to make sure that it’s not a problem," Rosengren said.
In prepared remarks, Rosengren said the current level of the Fed's policy interest rate is appropriate for the near term.
Rosengren voted against all three rate cuts made by the Fed this year and has repeatedly warned that lower rates could encourage excessive risk taking and over-leveraging, which could create more risks during a downturn. Rosengren will not have a vote in monetary policy decisions next year, but he will participate in deliberations.
During the interview, Rosengren said he is still worried that lower rates could encourage corporations to take on excessive risk and borrow too much.
The policymaker said companies that are over-leveraged may have to lay off more workers in a downturn, which could amplify losses and cause more damage to the economy.
"If you look at the last two recessions, they were not situations where inflation got out of control," Rosengren said. "They were situations where asset prices went way up and then came way down. So if your goal is to avoid recessions, I think we need to be pretty focused on asset prices not just inflation."
He added that he thinks it is the "perfect time" for the central bank to raise the countercyclical capital buffer, which would require firms to hold more capital and would leave them better equipped to handle a downturn.Original Article