By Michael S. Derby
WASHINGTON, Dec 10 (Reuters) – The Federal Reserve on Wednesday said that it would 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 December 12, 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.
The Fed said the first round of bill buying will be “elevated for a few months” and after that buying will be “significantly reduced.”
The restart of bond buying that will once again expand the size of Fed bond holdings comes hot on the heels of the Fed’s decision to stop shrinking the size of 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.
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.
A number of analysts had expected a swift shift to renewed asset buying, although many had been projecting sometime early next year as a starting point. The Fed’s move to expand holdings again may be a move to bolster liquidity over the end of the year, which can often bring large levels of short-lived 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 represent a change in the underlying stance of monetary policy.”
Speaking on the same day, Roberto Perli, who manages the implementation of monetary policy at the New York Fed, said “given what we know today we probably won’t have to wait long” before the expanded buying kicked off.
(Reporting by Michael S. Derby; Editing by Andrea Ricci)
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