How the Fed is Moving Ever So Slowly Toward Normalcy

The market nail-biting isn’t over, but the FOMC meeting is, and the resulting directive brought a sigh of relief to the equity and bond markets. The statement that followed the meeting has a real change in marching orders for those conducting open market operations (buying/selling securities to implement policy), but the change is in the pace of being accommodative, which is not perceived the same as a move to tighten.

Today (January 26), the Federal Open Market Committee (FOMC) decided to continue to steepen the taper of their bond purchases. While the reduction each month, as decided at the last meeting, would have had the purchases completed by June, the increased reduction (less tapered) brings these bond purchases to an end in early March. The directive to the Fed’s Open Market Trading Desk (the Desk) is to increase purchases to the System Open Market Account (SOMA) by a lesser amount than previously. This will still inject money into the economy and have the impact of holding longer-term rates down, but it will do it with a less pronounced impact.

Along with these purchases, the Desk was told to maintain the policy of reinvesting at Treasury auction all maturities and interest payments from Treasury securities and reinvesting cash flow from mortgaged Backed Securities (MBS).

For Treasury securities, monthly purchase schedules won’t be published after mid-February because new purchases will end in early March. The Desk will continue to roll over maturing Treasury security holdings by replacing maturing securities with newly issued securities available at Treasury auctions.

Rollovers are typically accomplished by bidding at Treasury auctions for an equal par amount to the value of SOMA maturities. The bids at Treasury auctions are placed “non-competitive” and are treated as add-ons to announced auction amounts.

Net increases in purchases will end in early March. The regular monthly purchases will continue to reflect the reinvestment of principal payments from agency debt and agency MBS into agency MBS using the secondary market. These purchases will continue to target recent 15 and 30-year mortgage securities.

Not a Tightening Move

The Committee was clear that it views changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy. It reiterated it will determine the timing and pace of reducing the size of the Federal Reserve’s balance sheet so as to promote its goals of maximum employment and price stability. The Committee expects that reducing the size of the Federal Reserve’s balance sheet will occur after it has begun to increase the Fed Funds target rate. 

The FOMC appears to want to return to normalcy as they stated, “In the longer run, the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.”

While it appears that a Fed Funds hike is coming, perhaps as early as March, the FOMC also reserved the right to change its mind as needed, “The Committee is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments” the Fed said in its statement.

Paul Hoffman

Managing Editor, Channelchek

Suggested Reading

Why a Less Dovish Fed Doesn’t Translate into a Hawkish Fed

Can the Fed Stop Inflation?

Sources

https://www.newyorkfed.org/markets/opolicy/operating_policy_220126

https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126c.htm

https://www.newyorkfed.org/aboutthefed/fedpoint/fed27.html#:~:text=The%20System%20Open%20Market%20Account,outright%20and%20a%20temporary%20basis.

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