The Fed reverts to pre-2009 balance sheet management where the balance sheet grows with or less than the economy.
By Wolf Richter for WOLF STREET.
In the FOMC statement on Wednesday, the Fed said that it would let the balance sheet grow “as needed to maintain an ample supply of reserves on an ongoing basis.” That supply of reserves has become tight enough, after three years and $2.4 trillion of QT, and lots of inflation, to cause substantial turmoil in the repo market starting in September.
The New York Fed provided additional details about these “Reserve Management Purchases” or “RMPs,” under which the Fed will purchase “shorter-term Treasury securities,” mostly Treasury bills (terms of 1 year or less), and if needed Treasury securities with remaining maturities of 3 years or less.
The mounts of the RMPs will vary. The NY Fed’s operating policy note on Wednesday said that the RMPs “will be elevated for a few months” – $40 billion the first month, starting December 12 – “to offset expected large increases in non-reserve liabilities in April [due to tax payments, more in a moment].”
And then, the RMPs “will likely be significantly reduced in line with expected seasonal patterns in Federal Reserve liabilities.”
“Purchase amounts will be adjusted as appropriate based on the outlook for reserve supply and market conditions,” the note said.
MBS that will continue to run off at a pace of about $15-20 billion a month via passthrough principal payments will be replaced by T-bills, as per the FOMC statement of the October meeting, and confirmed in the FOMC’s Implementation Notes today.
Before 2009 and QE, the Fed’s balance sheet always grew with the banking system and with the economy, driven by demand for the Fed’s liabilities; the largest liability at the time was currency in circulation (paper dollars). The chart shows the balance sheet growth from 2003 to 2008, before QE started. At the time, the Fed held mostly T-bills and repos. The ups and downs were caused the by the repos with which the Fed attempted on a daily basis to bracket short-term interest rates:
With today’s policy shift, the Fed reverts to pre-2009 balance sheet management, where the balance sheet grows with or less than the economy; total assets were for years above 6% of nominal GDP but on a slightly downward slope (see chart below).
In 2009 and after, QE inflated the ratio. But keeping the balance sheet flat in 2014 through 2017 deflated the ratio, though not as fast as QT-1 and QT-2.
How much in purchases to keep the Total-Assets-to-GDP ratio on a slightly declining trajectory, as it had done before 2009? Nominal GDP grew by $1.34 trillion over the 12-month period through Q2 (last GDP data available). If nominal GDP continues to grow at that pace, the Fed would have to purchase less than $1.34 trillion in securities to keep the Total-Assets-to-GDP ratio on declining trajectory.
And that may be the suggestion in this sparse preliminary announcement; the RMP amounts may not be large enough to keep the balance sheet growing with the economy; at the suggested figures, the balance sheet will grow, but quite a bit less than nominal GDP, and the Total-Assets-to-GDP ratio will continue to decline, but at a much slower rate than under QT.
During periods of QE, the ratio rose (QE-1, QE-2, QE-3, and pandemic QE). During periods of not-QE and QT, the ratio fell:
The monthly amounts will be announced around the 9th business day of each month, along with a schedule of tentative purchase operations for the following 30 days.
This is all about dealing with the demand for the Fed’s liabilities (liquidity that others have deposited at the Fed). On the current balance sheet, the largest liabilities are:
- Reserve balances: $2.86 trillion (liquidity banks deposited at the Fed)
- Currency in circulation: $2.43 trillion (liquidity people, entities, drug dealers, etc. around the world exchanged for Federal Reserve Notes (paper dollars)
- TGA: $900 billion (government cash on deposit at the Fed)
- Reverse repurchase agreements: overnight reverse repos: down to near $0; reverse repo with “foreign official accounts” (USD cash from other central banks): $330 billion.
Large tax payments around Tax Day in April shift liquidity from bank accounts, and therefore from reserve balances, to the government’s checking account, the TGA, and drain reserve balances substantially and rapidly. This also happened but to a lesser extent around September 15 when estimated corporate tax payments drained reserves and flowed into the TGA and started causing the ripples in the repo market that were then made worse by the shutdown when the government didn’t disburse some of the funds in the TGA, and therefore didn’t move them back to the reserves.
Both, reserve balances and the TGA are liabilities on the Fed’s balance sheet, and fund shift between them, which could quickly and problematically drain reserves around Tax Day in April. So the Fed is trying to prevent another repo market blowout.
We also know that the RMPs are not QE from the way they were introduced. When the Fed kicks off QE, it makes a big deal out of it, with big upfront numbers, with Powell standing there and touting them in front of the world – remember March 2020? – to obtain the “announcement effect,” which may be the most powerful aspect of QE. By contrast, the RMPs were a low-key add-on to the FOMC statement, with plenty of discussions about it beforehand that explained what those RMPs are and why’re they’re needed for liquidity purposes.
In case you missed it, the theory and charts of the reserve management purchases here: The Fed Will Talk a lot about “Reserve Balances” and “Reserve Management Purchases” at its FOMC Meetings
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