The Federal Reserve said Friday that it would begin buying government-backed securities to expand its balance sheet, a move meant to keep an obscure but critical corner of financial markets functioning smoothly.
Now officials seem to be hoping the public will understand their motivation.
Unlike its postrecession bond-buying campaigns, often called quantitative easing, or Q.E., the new effort is not monetary stimulus, the Fed stressed. Instead, the central bank is trying to keep money markets in check after a messy episode in which interest rates for repurchase agreements — essentially short-term loans between banks and other financial institutions — spiked in September. The run-up spilled over into money markets, pushing the Fed’s policy rate temporarily above the range that policymakers were targeting.
By expanding its balance sheet, the Fed will increase the financial system’s supply of bank reserves, which are currency deposits at the central bank. Doing so should keep episodes like last month’s from repeating by creating a steady supply of dollars to smooth over tumultuous moments.
Here’s what the plan will look like, how the Fed is trying to convince the world that it is not a new round of Q.E. and why it matters whether that message sticks.
The Details
The Fed plans to buy Treasury bills, which are shorter-dated government debt, at an “initial” pace of about $60 billion from mid-October to mid-November, it announced Friday. It will then adjust both the timing and amounts of bill purchases “as necessary to maintain an ample supply of reserve balances over time.” The buying will continue at least into the second quarter of 2020.
New purchase amounts will be announced on the ninth business day of each month.
The Fed will also continue to intervene in the market for repurchase agreements, something its New York branch began to do last month — a first since the financial crisis — as rates climbed. The Fed will keep those operations going “at least through January of next year,” according to the release, “to ensure that the supply of reserves remains ample even during periods of sharp increases in nonreserve liabilities.”
Markets expected the Fed to do something to prevent money market turmoil after September’s troubles. The Fed’s chair, Jerome H. Powell, said just this week that a plan was coming “soon.” But the size of the package surprised some onlookers, including Priya Misra, head of global rates strategy at TD Securities.
“This is building a buffer, and it’s doing it faster than I thought,” Ms. Misra said.
While the amount could change, buying $60 billion in Treasury bills over a month is substantial, even by the Fed’s standards. For context, the Fed bought about $85 billion in bonds each month during its final round of quantitative easing, which started in 2012.
Yet the new purchases are different from those postcrisis packages.
An Important Distinction
Mr. Powell and his colleagues have repeated, time and again, that the current balance sheet expansion should not be confused with quantitative easing.
“It’s not a change in our policy stance,” the president of the Federal Reserve Bank of Minneapolis, Neel Kashkari, said in an interview Friday. The amount of bills the Fed buys “is going to depend on how much demand for dollars grows,” he said, and the adjustable approach to buying “gives us a lot of flexibility.”
The simple fact that policymakers are trying to draw the distinction is important, because Q.E. worked to a large extent through market expectations — investors saw it as a sign that the Fed would not lift interest rates soon. That caused them to dial back their expectations for rate increases and helped to keep money cheap and easy to borrow.
To drive home the point that there is no broader policy signal this time, officials made the new package look unique. The Fed is buying only Treasury bills, for one thing. The Fed’s recession-era buying focused on bonds, in a bid to make mortgages and car loans cheaper by pushing down longer-term interest rates. By concentrating this effort on short-term debt, the Fed is forgoing that sort of stimulus.
Officials also announced the package between their scheduled meetings, whereas easing rounds were announced at policy-setting gatherings.
Still, some onlookers were skeptical that the Fed would manage to convince investors that this was not an attempt to bolster the economy, given the size of the purchases.
“When it swims like a duck and quacks like a duck, it’s hard to prove your intentions aren’t fowl,” Paul Ashworth, chief economist at Capital Economics, wrote in research note.
Why Does It Matter?
It is important that the Fed’s message sticks. The Fed will be short on room to cut interest rates when the next recession hits, because they are already at just 2 percent — leaving the central bank with far less than the five percentage points of cuts it made in the 2007 to 2009 downturn. That means bond-buying will be an essential part of the Fed’s future easing packages, and one to be used in case of emergency.
“They want to keep Q.E. as something special,” said Laura Rosner, a co-founder of MacroPolicy Perspectives. “I don’t think they want to send a signal that things are bad.”
But if central bankers communicate clumsily, they could create problems for themselves. They are telling investors that their bond purchases do not stimulate the economy — yet they will probably need investors to believe that Fed bond buying is stimulative come the next recession.
“I see some tensions there,” Ms. Rosner said.
Why Do It Now?
The Fed did not have a lot of time to come up with this plan: Last month’s market volatility was bad, and unexpected, news for the central bank.
Rates on repurchase agreements, or repos, shot higher starting Sept. 16 as a confluence of events sucked dollars out of the financial system. A deadline for corporate tax payments and issuance of new Treasury debt led to a dollar shortage — stresses that were unusual but not unexpected. The disruption spilled over into other money markets, temporarily pushing the Fed’s policy interest rate, the fed funds rate, above the range policymakers had set for it.
That raised alarm bells. Officials had decided this year that they wanted to continue setting interest rates in what they called an “ample reserve” framework. In such an approach, the central bank keeps its balance sheet holdings big enough to leave plenty of cash in the financial system. Banks keep their extra cash on deposit at the central bank, and the Fed adjusts interest rates by changing how it pays on those excess holdings, commonly called reserves.
The Fed wanted to shrink its balance sheet to a point where it could run the system without regularly intervening in markets. September’s repo issues suggested that it might have gone too far, getting to a point where reserves — which no longer move around the system as easily as they once did — were insufficient to smooth over turbulence.
Now, the key is to get back to a place where reserves are plentiful, all the while hewing to the refrain Mr. Powell has now aired several times: “This is not Q.E.”