When the Federal Reserve decided to execute a new course of monetary policy in November, it had a problem. It wanted to buy more longer-term Treasury securities, but it was already nearing its concentration limit for the amount of each specific Treasury security it could hold. But since the rule was self-imposed, it lifted the limit, effectively doubling the amount it can purchase of any given Treasury security issue. This is a pretty big change.
Liz Capo McCormick of Bloomberg reports:
The central bank had temporarily relaxed its 35 percent limit in November when announcing additional purchases of $600 billion of Treasuries through June. The New York Fed in a statement today gave allowable purchase percentages for three brackets in its system open market account, or SOMA, consisting of securities it holds, from more than 30 percent to 70 percent.
For example, let's say that the Treasury issues $50 billion of 5-year bonds in January. Now, the Fed can own up to $35 billion of the security. In the past, it could only hold $17.5 billion.
It's a little unclear whether, in the long-term, this policy change really matters. While it might sound startling that the Fed can own up to 70% of a particular Treasury issue, the change is necessary for the Fed to be able to carry out its latest round of quantitative easing. Without lifting this ceiling, the Fed would have little flexibility to shape the universe of bonds it would purchase. Now its policy can affect a broad range of Treasury bond yields.
This change may of smell a little of the Fed monetizing government debt. In theory, it can now purchase up to 70% of a debt issuance. Yet the announcement actually relieved the market. The article also quotes a source:
"This gives some clarification on what the end game is for the Fed with regard to individual security purchases," said Thomas Simons, a government-debt economist in New York at Jefferies Group Inc., one of the 18 primary dealer that trade with the central bank. "There are some issues that the Fed holds over 40 percent and people were wondering if they would remain cheap if there was no liquidity because the Fed owns them all. Now not only can the Fed not own 100 percent of an issue, it will also take them considerably longer to increase its holdings."
At least now we know that the Fed won't buy up all of some Treasury security, if it instead did away with the limit altogether. There will also be a system in place to ensure that the Fed purchases a diverse portfolio of Treasuries, as it can only purchase 5% of a security in each operation.
So the Fed isn't monetizing the national debt, at least not exactly. It's worth noting, however, that the Fed's balance sheet already has the highest amount of Treasuries it ever has. Its Treasury holdings should exceed the $1 trillion mark in December or January. Depending on how quickly they mature, the size of its Treasury balance could increase by as much as 50% by June through its recently announced buying efforts. That's a pretty big chunk of the national debt for the Fed to have in its pocket -- probably around 10%.
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