The Federal Reserve hopes to calibrate the proper size of its balance sheet before it decides on the composition of that balance sheet, Fed Chairman Jerome Powell said on Wednesday.
In mid-October, the Fed announced that it would begin expanding its balance sheet by buying about $60 billion a month in Treasury bills. The move is designed to expand the Fed’s holdings to support higher levels of reserves held at banks and broker-dealers.
The move stems from a brief episode overnight on Sept. 16 and 17, when rates on overnight borrowings of cash spiked as high as 10% for some dealers, well out of range of the Fed’s target for where interest rates should be. By resuming “organic” growth of the balance sheet, broker-dealers and banks should similarly increase the amount of reserves in the financial system, providing more liquidity and hopefully preventing the crunch that bid interest rates higher in mid-September.
“One thing that was surprising about the episode was that liquidity didn’t seem to flow as one might have expected,” Powell said Oct. 30.
Powell had hinted in the Sept. 18 policy-setting meeting that balance sheet growth could be warranted at some point, and said Wednesday that the Fed is continuing “forensic work” on why banks did not make more reserves available in the overnight repurchase agreement operation, or “repo” market.
Powell said he was surprised because surveys of banks showed that market participants appeared to have comfortable levels of reserves but did not lend excess cash in the repo market.
To provide more relief to the repo market, the New York Fed has offered a temporary daily operation to transact its own swaps with primary dealers. At first the New York Fed offered about $75 billion each day, but last week expanded that facility to at least $120 billion each day.
Fed officials have reiterated that the balance sheet growth and repo operations are not “quantitative easing” because they are not designed to create stimulative monetary policy.
“These are purely technical measures,” Powell said Oct. 30.
Composition
The Fed’s efforts on combating another repo crunch are keeping policymakers busy, and Powell says the Fed is not currently thinking about longer-term questions like if it should unload its holdings of mortgage-backed securities.
“It’s an issue but its not an issue that we’re currently working on or reaching a decision or anything like that,” Powell said in response to a question from Yahoo Finance on Wednesday. “The question of the longer-run maturity composition of the balance sheet is a big one, and it’s one we’ll return to over time, but not imminently.”
Fed officials like St. Louis Fed President James Bullard have called for a more “neutral” balance sheet that would clean up the Fed’s holdings by replacing agency debt and mortgage-backed securities with shorter-term Treasuries.
“That would keep you completely out of the idea of favoring any particular sector of the yield curve or particular sector of the economy,” Bullard said at a conference in February.
As of Oct. 23, the Fed was holding $1.46 trillion of mortgage-backed securities on its balance sheet.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.
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