Monday, August 24, 2009

Fed MBS Purchases & Balance Sheet

Below is a graph of the current (8/19/09) progress of Fed. MBS purchases and settlements:


So far the NY Fed has made net purchase commitments of over $760B of MBS, while only about $600B of these trades have settled so far. The Fed is creating new reserves to fund these purchases, so the Fed balance sheets stands to increase when these trades settle, unless the Fed is able to reduce other items on the balance sheet by an offsetting amount.

This year the Fed has been able to hold the balance sheet fairly steady at about the $2T level, by reducing certain items while it has purchased over $600B of MBS and over $300B of Treasury and US Agency bonds. Last week the balance sheet expanded by about $45B, the snip below from the H.4.1 report highlights some of the larger transactions:




You can see that Securities Held Outright rose by $76B due mainly to MBS and Treasury purchases. This amount was somewhat offset by reductions in Term Auction Credit and Central Bank Liquidity Swaps.
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I've numbered 3 line items that I think represent the main options for the Fed to work to reduce if they, for political reasons, desire to keep the balance sheet steady at about the $2T level, while they continue with their current goals of purchasing an additional $800B of securities over the remainder of this year. Even if they are able to reduce all 3 of these special liquidity programs to zero, the balance sheet stands to expand considerably, and the additional new reserves created could put upward pressure on bond prices over this time.

10 comments:

RSG said...

"and the additional new reserves created could put upward pressure on bond prices over this time."

Mike, with ff rate at zero why would additional reserves put upward pressure on bond prices?

Mike Norman said...

Upward pressure on bond "prices," not interest rates. (Prices move inversely to rates.) Bonds should rally because some of that larger quantity of excess reserves will go to buy Treasuries.

RSG said...

That seems like a circular argument as buying treasuries adds to aggregate reserves.

Matt Franko said...

RSG,
The theory here is that if the Fed buys the MBS/Treasuries with new reserves, while holding other factors affecting reserve balances steady, the sellers of these on-the-run MBS/Treasuries will receive net new reserve balances in payment from the Fed that they will to some extent re-deploy into the bond markets (buying other OTR MBS/Agency/Treasuries) and thus apply additional buying that on net should support prices.

RSG said...

Matt, except for the part of holding other factors affecting reserve balances steady, how is that not circular?

Mike Norman said...

RSG: Only when the Fed buys from the public, which it has. If the public buys from itself there is no change in reserves. I buy from you, my account is debited reserves and your account gets a credit. I get the security, you get the cash.

Matt Franko said...

RSG,
thanks for the comments here...

When in your previous post you said "buying treasuries adds to aggregate reserves." who is your buyer in that sentence? (Im trying to understand your point)

RSG said...

Matt, The fed... it buys Treasury securities from the public and credits the sellers' banks with additional deposits at the Fed. Conversely the Fed sells treas to the public from its own portfolio when it needs to decrease aggregate bank reserves.

my simple point was trying to understand Mikes comment about how additional new reserves could put upward pressure on prices/downward pressure on yields if all that was happening was that the fed and the public were selling treas back and forth to one another.

Matt Franko said...

RSG,
OK thanks..

Yes I see your point there, but I think we are in a somewhat unique time in history this year (I guess due to the crisis) where the Fed has come right out in a press release and up front stated that they intend to BUY $1.75T of securities this year, not net sell any, but BUY with new reserves. So everything else even, that should be supportive of bond prices in theory.

Mike Norman said...

RSG: Only the Fed or the Treasury can supply new reserves. When the Fed adds reserves through open market operations (buying securities) it reduces the amount of securities held by the public, but raises the level of reserves. Thus, you have a situation where more "money" is chasing fewer bonds.