The Federal Reserve’s balance-sheet unwind is set to ramp up this week, which means the central bank will finally begin unloading the Treasury bills it started amassing almost three years ago.
As part of its broader plan to reduce its US$9 trillion ($12.58 trillion) portfolio, the Fed will boost its monthly caps for the amount of Treasuries and holdings of mortgage-backed securities that it will let mature to US$60 billion and US$35 billion, respectively, while using its US$326 billion stash of T-bills as filler when coupons run below the monthly level. September will be the first month that bills will be redeemed since coupons will fall below the monetary authority’s new cap.
The Fed’s portfolio has US$43.6 billion of Treasury coupons maturing in September, which means that officials will need to let go of US$16.4 billion of bills as well. It will also need to let another US$13.6 billion run off in October. These will be the largest declines for the bill portfolio until September 2023.
There’s been keen interest in the Fed’s bill holdings due to the fact that the last time the monetary authority undertook so-called quantitative tightening it didn’t own any of the securities. It’s also critical for money-market traders who have been struggling to find assets in which to invest. They’ve largely opted to park excess cash at the reverse repurchase agreement facility, and a full rundown of the Fed’s Treasury bills would’ve provided investors with a jolt of supply.
“This is the first time the Fed is allowing bills to run off their balance sheet, three years after they started buying them quickly due to a reserve shortfall,” said TD Securities strategist Gennadiy Goldberg. “QT is hitting its full stride.”
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A drop in reserves below the system’s comfort level in September 2019 helped fuel a disruptive spike in repo rates, a keystone of short-term funding markets. As a result, the Fed began buying roughly US$60 billion of Treasury bills a month to beef up its reserve balances -- in addition to conducting daily repo operations.
While the central bank expected to buy bills through the second quarter of 2020, the economic turmoil brought on by the pandemic spurred a wave of fiscal and monetary stimulus, flooding the financial system with cash and ensuring reserves were more than ample. The difference is Treasury has since dialled back the amount of bill supply creating an imbalance where short-term investors are left with very few investment options beyond the Fed’s RRP.
Bill supply is finally starting to edge higher, though it’s still not enough to satiate the demand. The expectation among Wall Street strategists is that as the path of the Fed’s interest-rate hikes slows and Treasury continues boosting the amount of T-bills it issues, it will draw those reticent investors away from the haven of the RRP and back into the market.
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Still, the week-to-week and month-to-month bill holdings will have no bearing on the market supply of bills as the Treasury factored the redemptions into its quarterly borrowing plans, according to Wrightson ICAP. There are longer-term concerns because as the Fed has less securities to lend to dealers in its daily operations, it will impede their ability to cover short positions and make it more expensive to borrow in the repo market.
“From a cash-market perspective, nothing will change when the first bill runoff takes place on Thursday,” Wrightson ICAP economist Lou Crandall wrote in a note to clients Monday.
