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NEW YORK, Sept 30 (Reuters) - The Federal Reserve Bank of New York detailed on Thursday expanded collateral and three-party repo operations announced earlier this month to help ensure adequate funding for financial markets in case of Year 2000 computer glitches.

The New York Fed, which is the U.S. central bank's arm in financial markets, published several weeks ago a series of technical steps to provide ample liquidity ahead of year-end and promote smooth functioning of money and financing markets.

The bank said then it will accept a broader array of collateral over longer periods when it adds liquidity to the U.S. banking system through daily operations between October and April 2000.

The New York Fed will also start selling options that would allow market players to be sure they can tap funding at any specific date in the two quarters ahead.

``Because of the now broad pool of eligible collateral, we are considering whether we will need to conduct three parallel operations each time we inject reserves,'' the New York Fed said Thursday.

The three operations would allow dealers to separately price financing rates on Treasury securities, agency debt securities, and agency pass-through mortgage backed securities.

The New York Fed release on Thursday outlined terms for auctioning options on overnight repurchase transactions. The terms have not yet been finalized and primary dealers of government securities can still comment on the proposals until Monday.

Under the new measures, the New York Fed will now only temporarily accept pass-through mortgage securities securities of Government National Mortgage Association (Ginnie Mae), Freddie Mac and Fannie Mae as well as U.S. Treasury STRIPs where the coupon and the interest on Treasury issues are traded separately.

Until now, the Fed bank only accepted debt issued by Freddie Mac and Fannie Mae that enjoys near-Treasury credit status.

The bulk of financial markets' daily operations is usually easily financed by borrowing against top-grade collateral -- mostly U.S. Treasuries. But fears of ``Y2K'' computer glitches may make liquidity harder to get or more expensive than usual in the computer-driven banking system.

The Federal Open Market Committee voted at its last meeting on August 24 to authorize the New York Fed to provide a temporary Standby Financing Facility through the auction of options on temporary transactions.

The Fed will charge a premium for the options of at least one and a half percentage points above the federal funds rate for overnight inter-bank lending. But dealers would not need to exercise their options if the fears are not founded and liquidity remains plentiful.

-- (M@rket.trends), September 30, 1999

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U.S Y2K liquidity premium bigger than in euro zone

By Aline van Duyn

LONDON, Sept 30 (Reuters) - Markets are charging a bigger premium for borrowing money over the millennium weekend in the U.S. than in the euro zone, although the Federal Reserve has taken steps to ease a liquidity shortage then and the European Central Bank has not.

Three-month interbank rates set on September 28 versus September 29, which mature on December 31 1999 and January 4 2000 respectively, show the Y2K premium on an annualised basis is 12.8 percent for the U.S. and 8.8 percent for the euro zone.

Concern that the fear of Y2K-related computer problems will make it more difficult and costly to buy and sell securities over the year- end means more is being charged for money borrowed over the so-called ``millennium turn.''

While the Y2K liquidity premium is less in Europe, gloomy interest rate markets are at least partly due to expectations the European Central Bank is also poised to raise official interest rates to offset the impact of acclerating world growth.

``The Y2K premium is more for the U.S. than Europe, although the actual spike in rates between now and the year-end is higher for the euro zone,'' said Steve Major, chief bond strategist at ING Barings.

``This is quite surprising given the ECB has so far done nothing specific ahead of the year-end, whereas the U.S. Federal Reserve has.'' The Fed took measures on September 8 such as expanding collateral to boost liquidity.

Short-term interest rates are already higher in the U.S. at 5.25 percent versus the euro zone's 2.50 percent.

Tony Norfield, head of global treasury research at ABN AMRO, said the premium in the euro zone did not appear so far to reflect worries about the way short-term interest rates are set but they could still increase.

FIXED REPO TENDER

The ECB currently has a fixed repo tender, which means banks bid for more money than they need, whereas a variable rate tender is needed accurately to gauge the liquidity changes during that time, he said.

``The whole 'turn' issue is tied up with the need to have a variable rate system in Europe,'' Norfield said. Norfield also said it was hard to separate out the millennium and the interest rate hike expectations in interest rate futures, such as the euro zone's Euribor.

Major at ING Barings said the markets were now pricing in a 100 percent chance of a euro rate rise this year, versus about a 15 percent chance of further rate rises by the U.S. Fed.

``The euro markets are at the moment much more focused on interest rate risks than Y2K risks,'' Major said.

Beyond changing its rate setting to a variable scheme, the ECB might also adopt a similar tool it used during the introduction of the euro, by setting a narrow interest rate band between its emergency lending and borrowing windows.

There was some speculation that the ECB had met this week to discuss the issues.

David Brown, chief European economist at Bear Stearns, said there were some examples of Y2K defensiveness coming in, but it was hardly sufficient to raise eyebrows at central banks.

For example, a Reuters poll of UK equity funds showed cash holdings had only increased to 6.3 percent from 6.2 in August.

``Y2K uncertainties will largely revolve around how high short-term rates will get over year-end and how well central banks will smooth things down,'' he said.

-- (M@rket.trends), October 01, 1999.