Fed says it will start technical buying of Treasury bills to manage market liquidity

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By Michael S. Derby

WASHINGTON, Dec 10 (Reuters) – The Federal Reserve on Wednesday said it would imminently start buying short-dated government bonds to help manage market liquidity levels to ensure the central bank retains firm control over its interest rate target system.

The technically oriented purchases will commence on Friday, the central bank said as part of the policy announcement associated with its latest Federal Open Market Committee meeting. When it begins buying, the initial round will total around $40 billion in Treasury bills per month.

The Fed said in a statement that its buying “will remain elevated for a few months to offset expected large increases in non-reserve liabilities in April,” adding, “after that, the pace of total purchases will likely be significantly reduced in line with expected seasonal patterns in Federal Reserve liabilities.”

Speaking after the Fed meeting, Fed Chair Jerome Powell said the buying is “solely for the purpose of maintaining an ample supply of reserves over time, thus supporting effective control of our policy rate.” He added, “these issues are separate from and have no implications for the stance of monetary policy.” 

Many Fed watchers had expected a restart of asset buying but most had projected it to kick off early next year. As the Fed moves forward with its new asset purchases, it could face challenges from some who see the buying as a form of stimulus rather than a technical adjustment.

Scott Skyrm of money market trading firm Curvature Securities noted the pace of buying “is greater” than the current runoff of mortgage bonds held by the Fed, so the new operations represent “an injection of liquidity” into the market. 

The restart of bond buying that will once again expand the Fed’s balance sheet comes hot on the heels of its decision to stop shrinking its holdings as of the start of the month. Since 2022, the central bank had been allowing Treasury and mortgage bonds it owns to mature and not be replaced, in an effort called quantitative tightening, or QT.

The effort was aimed at draining the oceans of liquidity the Fed added during the COVID-19 pandemic to stabilize markets and provide stimulus in a time of near-zero rates. QT took the overall size of the Fed’s balance sheet from $9 trillion in 2022 to its current size of $6.6 trillion.

The Fed announced an end to QT in late October amid increasing signs that liquidity had tightened enough to potentially complicate the management of the central bank’s federal funds rate, its main tool to achieve its inflation and employment goals.

In October, key money market rates began drifting higher as some financial firms tapped in size the Fed’s Standing Repo Facility, which provides fast loans collateralized with Treasury and mortgage bonds. That portended a potential loss of control over the federal funds rate, spurring the Fed to end QT. Also, what had been fairly steady levels of reserves parked by financial firms had begun to tip lower. 

“We knew this was going to come,” Powell said.  “When it finally did come, it came a little quicker than expected, but we were absolutely there to take the actions that we said we would take” to ensure the market has the needed level of liquidity. As for why the initial round of purchases is so large, Powell noted the looming April 15 tax date which generally brings liquidity challenges to the market. 

Powell noted that the economy’s underlying needs in terms of reserve growth point to about $20 to $25 billion per month in purchases, suggesting that once the Fed gets past the April tax date, the buying rate could be around those numbers. 

INEXACT SCIENCE 

Between the announcement of QT’s end and its actual conclusion, Fed officials cautioned that they’d soon need to rebuild liquidity. The Fed is seeking to maintain what it views as an “ample” level of liquidity that keeps the federal funds rate in its range while allowing for normal money market volatility.

New York Fed President John Williams said on November 12 that the analysis to determine when reserves reach ample levels is an “inexact science.” He said once the desired level of reserves is achieved “it will then be time to begin the process of gradual purchases of assets,” noting this type of buying “in no way represents a change in the underlying stance of monetary policy.”

The Fed’s shift to rebuild its balance sheet shows how officials took to heart the difficult lessons of the last time it navigated a similar turning point in its effort to manage market liquidity. The last chapter of QT ended roughly in September 2019 with unexpected volatility in short-term rates, which forced officials to rebuild liquidity through both temporary and permanent means. 

In this episode, the Fed sought to avoid a replay and was in part aided by new tools like the Standing Repo Facility. All of that collectively has kept the federal funds rate within its range and operating as the Fed wanted.  

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(Reporting by Michael S. Derby; Editing by Andrea Ricci)