According to many economists, the policies enacted by the Federal Reserve fail to successfully stabilize the bond market. The Fed is effectively unable to predict the reserves deficiency in the banking system due to the time frame of the process. Much of the time, the ultimate investor response to the repo process is not known for six months or more. Also, intra-day behavior of the market is highly volatile. The spread between the overnight rate of the bonds and the key policy rate of the European Central Bank has created disorganization within the system.
The Fed does use temporary repos in its open market operations effectively to adjust the liquidity in the banking system. This increases the vulnerability of private bond market participation in regards to disturbances in the normal price formation process. Generally, The Fed conducts short-term open market operations prior to the opening of the market. It essentially refinances existing positions in the bonds. While this should not effect the volatility of the price formation process, some economists have found that the Fed's actions impact the overall market negatively. On days when open market operations are not conducted, the market stabilizes.
On days when auctions occur, the volatility of the market also increases. Bond returns fluctuate heavily due to the repo and reverse repo process. The Fed uses a pay-your-bid auction method for primary dealers as well as offering other dealers an opportunity to refinance a leveraged position. This refinancing is generally a lower cost than in the private repo market, allowing the Fed to stabilize demand in funding. This does allow bond dealers to submit a larger portion of securities than it otherwise could at private auctions.
