When The Fed lowered interest rates earlier this month, investors got want they wanted. But, the Central Bank also began “reserve management purchases,” buying $40 billion a month in short-term treasuries.
It was an important move that was overlooked by many, Business Insider said.
Investors often don’t notice changes to the Fed’s balance sheet. Investors primarily trade based on rate cuts and expectations for the path of monetary policy. Yet, Business Insider said, the Fed’s bond purchase programs historically have been an important tool for both influencing interest rates as well as providing liquidity to markets.
The announcement of a new bond-buying initiative likely was one of the most important details of the Dec. 10 meeting, said Steven Blitz, a Managing Director and Chief U.S. economist at TS Lombard.
“The Fed cut and said ‘that’s all folks’ until the data roll in, but that was no surprise and far less important than the signalling from the return of balance sheet purchases,” Blitz wrote.
Here’s what’s happening and why it’s a big deal for markets.
In its recent statement, the Federal Open Market Committee said it believed the Fed’s reserve balances had declined to “ample levels,” and that it would start purchasing short-term U.S. Treasuries “on an ongoing basis.”
Fed to Buy $40B of Treasuries A Month
The Fed will buy about $40 billion of Treasuries a month before reducing that amount in the spring, Business Insider noted. Reserve balances at the Fed dropped to a low of $2.8 trillion in October, its lowest level in nearly three years.
The latest purchase program is different than the Fed’s quantitative easing program, which is aimed explicitly at stimulating economic activity. The purchase program is meant to ensure stability in financial markets.
There are a few reasons the purchase program decision is important for markets and investors.
Low bank reserves can add to short-term funding pressures in the financial system. The Fed’s RMP program is a technical function of the central bank, rather than an update to any aspect of monetary policy. Still, it has implications for markets, Business Insider said.
Some market analysts have said the move raises concerns about the health of the banking system.
Michael Burry, the investor of “The Big Short” fame, said he believed the fact that the Fed has to provide liquidity support is a worrying sign.
“I would add if the US banking system can’t function without $3+ trillion in reserves/life support from the Fed, that is not a sign of strength but a sign of fragility,” Burry wrote in a post on X. “So I’d say US Banks are getting weaker way too fast.”
Central Bank Seeks Market Stability
Business Insider said that others view it as a necessary function of the central bank as it seeks to ensure market stability.
“Moderate balance sheet expansion will be necessary to accommodate the increased demand for reserves that accompanies ongoing economic growth,” strategists at Glenmede wrote recently in a note.
The beginning of RMPs marks the first time the Fed has meaningfully expanded its balance sheet since it ended its quantitative easing program in 2022, Deutsche Bank said.
“The 25bp cut is mostly in line with expectations, but the start of treasury purchasing ($40bn) is what drove the market reaction,” analysts at JPMorgan wrote in a note following the Fed meeting, pointing to the move up in stocks.
Morgan Stanley also chimes in, noting that while the Fed has emphasized RMPs are not QE, the result of added liquidity is ultimately similar.
“More importantly, these purchases provide additional liquidity for markets, and in combination with rate cuts, also suggest the Fed is likely less worried about missing its inflation target,” the bank wrote on Monday.
Bank of America said that the “QE-like” impact on markets could result in bond yields at the longer end of the duration curve coming down as well, according to Business Insider.
In BofA’s baseline scenario, which includes the Fed making roughly $380 billion worth of reserve management purchases in 2026, strategists said they expect the 10-year US Treasury yield to decline by 20 to 30 basis points.
Busines Insider said that is bullish for a couple reasons.
Lower bond yields in general encourage investors to stick with equities for better returns, but a lower 10-year yield specifically means potentially easier borrowing conditions for consumers and businesses.
“Fed’s RMP program will increase general market liquidity,” BofA strategists wrote of the bond market in a separate note last week. “With the Fed action, the market is on better footing and the large calendar to end the year should be bought.”
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