By Michael S. Derby
Oct 7 (Reuters) – Federal Reserve meeting minutes from last month’s policy meeting noted some officials believe it’s time for the central bank to get ready for bond market stress.
“Regarding balance sheet policy, a few participants observed that Treasury markets had been functioning smoothly but noted the importance of planning for market stress,” the minutes from the central bank’s September 15-16 Federal Open Market Committee meeting said.
These unnamed central bankers “suggested strengthening the Federal Reserve’s strategy, communications, and tools for addressing market dysfunction, should it occur, while limiting the Federal Reserve’s footprint in the Treasury market.”
Those comments came from minutes that described central bank deliberations during a period of market unrest. Officials raised rates at last month’s meeting, boosting them by a quarter percentage point to between 3.75% and 4%, as they tightened policy to contend with high levels of inflation. Officials also penciled in another rate increase by year’s end.
The shift in the path of monetary policy has been attended by a sharp rise in government bond yields that breached key levels and generated notable real-world increases in things like mortgage borrowing costs.
Fed officials have been attributing the rise in yields to a solid economic outlook, the impact of strong tech investment that’s caused government yields to rise to compete for investment, and geopolitical concerns. That said, the power of the move has caused some to worry about the state of the market in a time of huge government deficits and ongoing worries about the outlook for inflation.
These worries brush up against the Fed’s balance sheet because in the last two decades the central bank has addressed big periods of market stress with bond buying. The Fed dealt with the initial phases of the COVID-19 pandemic with big purchases of Treasury and mortgage debt before it transitioned those operations to a form of stimulus, for example.
BALANCE SHEET BALANCING ACT
That kind of buying swells the size of the Fed’s balance sheet. But new Fed Chairman Kevin Warsh is opposed to large Fed holdings and would like the balance sheet to be smaller. He’s named a task force to consider ways that might make that happen.
The comment in the meeting minutes “sounds like an oblique way to draw a line in the sand and signal to the market and the White House that the Fed’s thinking has not changed: It would intervene only if policy transmission is threatened, not simply because yields are rising rapidly,” said Derek Tang, an analyst at Monetary Policy Analytics, Inc.
He added that even if the Fed does step in, it would use tools like its liquidity-providing standing repo operations and the discount window as its first line of defense against an unsettled market. Notably, those two tools are in place and are essentially on autopilot, ready to respond to market needs as they emerge.
Meanwhile, Gennadiy Goldberg, head of US rates strategy at TD Securities, said he sees the comment from the minutes directed at managing technical Treasury bill buying aimed at bolstering reserve levels.
“Given that we tend to see some stresses heading into year-end, this may be the discussion of resuming [Reserve Management Purchases] in the next few months,” he said, adding, “we think the Fed may resume RMP at a modest pace before year-end to ensure everything is functioning smoothly.“
In an interview last week, Minneapolis Fed President Neel Kashkari cast doubt on the need for any broad central bank involvement in the bond market in the current situation.
“I see every indication that the Treasury market is functioning fine, so I’m not seeing a financial stability risk, and I don’t see any reason why the Fed would intervene, given that the market appears to be functioning just fine,” the official said.
(Reporting by Michael S. Derby; Editing by Andrea Ricci )
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