To support financial markets and the economy during the pandemic, the Federal Reserve has more than doubled its asset portfolio made up of Treasuries and mortgages to $9 trillion.
Officials are due to announce plans on how to reduce those holdings. While the design of their scheme is similar to a previous experiment taking place in the asset portfolio in 2017, the process will be faster and potentially more disruptive for financial markets than last time.
The Fed first did large-scale bond buying, which it called “quantitative easing,” during and after the 2007-2009 financial crisis. At a time when the Fed’s short-term interest rate was near zero, the buying was designed to stimulate economic growth by lowering long-term interest rates and pushing investors into riskier assets, booming stocks, corporate bonds and real estate. It stopped expanding its portfolio in 2014, and reinvested the outstanding securities proceeds in new contracts, dollar for dollar.
In 2017, when the Fed concluded that stimulus was no longer necessary, it began passively shrinking its portfolio — that is, by allowing bonds to mature without reinvesting the proceeds, rather than actively selling them in the open market.
This time around, officials once again opted for an essentially passive approach so investors don’t have to guess from one meeting to the next how the Fed might reassess bond redemptions.
But negative paybacks will be bigger and faster than they were five years ago. Then, concerned about how runoff would work, officials imposed a low cap of $10 billion on monthly runoff and slowly raised that limit to $50 billion over a year.
Officials recently indicated that in this round, they will allow $95 billion in securities to mature each month — $60 billion in Treasury and $35 billion in mortgage-backed securities — nearly double the caps than last time. The runoff is likely to start in June and hit new caps in just a couple of months instead of a year.
Unlike last time, the Fed also owns more than $300 billion in short-term Treasuries. The central bank has to decide how to let these bills mature. At their March meeting, officials discussed a plan under which they would allow Treasuries to be taken out of the portfolio in months when the maximum redemption limits for Treasuries are not binding. In other words, if you were to run out of only $45 billion of securities in one month, the Fed would allow $15 billion of securities to mature to maintain $60 billion of total cash flow each month.
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