The word is out that the Fed will rely on money market funds to help sop up the “excess” liquidity created by the Fed’s record shattering explosion of credit.

The Fed has been discussing it’s “exit strategy” ever since they pumped huge amounts of credit into the markets since mid-2008. The dilemma, in Ben Bernanke’s mind, is that if they tighten credit in an attempt to reduce the volume of “excess” reserves they may quash the recovery. On the other hand, if they don’t reduce the credit created they face the specter of inflation, perhaps very high inflation.

The plan is that the Fed will allow money market funds to purchase Treasury debt directly from the Fed, much as do primary dealers. According to the report:

The Federal Reserve is in talks with money-market mutual funds on agreements to help drain as much as $1 trillion from the financial system as policy makers prepare for the first interest-rate increase since June 2006, according to a person familiar with the discussions.

The central bank is looking to the money-market mutual fund industry which manages $3.2 trillion in assets because the 18 so-called primary dealers that trade directly with the Fed have a capacity limited to about $100 billion, estimates Joseph Abate, a money-market strategist at Barclays Capital in New York.

Money-market funds may welcome the opportunity to trade with the Fed after the financial crisis reduced the supply of safe assets in which they can invest. …

This has several ramifications. First, as U.S. savings continue to increase, more money has been flowing into the money market which has resulted in a jump in the amount of Treasuries bought by the domestic market. … Continue reading The Fed’s New Plan to Drain the Pond