Debt-Limit Dynamics Could Disrupt Money Markets, Says Fed's Perli
(Bloomberg) -- The current debt-ceiling impasse could threaten the Federal Reserve's ongoing balance-sheet runoff causing gyrations in the central bank's liabilities that create volatility in money-market rates, according to Federal Reserve Bank of New York's Roberto Perli.
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Once the debt ceiling is resolved the Treasury Department tends to rapidly rebuild its cash pile — the biggest liability on the Fed's balance sheet — resulting in a fast decline in other liabilities. This may especially affect bank reserves since the overnight reverse repo facility is 'largely depleted,' Perli, who oversees the central bank's securities portfolio, said Wednesday at an event hosted by the Money Marketeers of New York University.
'The longer the balance-sheet runoff continues while the debt ceiling situation persists, the higher the risk that, upon the resolution of the debt ceiling, reserves could rapidly decline to levels that could result in considerable volatility in money markets,' Perli said.
A key House Republican said Wednesday the US could hit the debt ceiling as soon as mid-May, earlier than estimates from Wall Street strategists. The level of outstanding US debt hit its statutory limit in January. The Treasury has since been using special accounting maneuvers and drawing down its cash reserves to prevent a payments default.
For several months officials said very little publicly about when they might stop reducing the Fed's balance sheet, a process known as quantitative tightening, or QT. However, minutes of the January Federal Open Market Committee meeting revealed policymakers had discussed the potential need to pause or slow the process until lawmakers can strike a deal over the government's debt ceiling.
Repo Pressures
Perli, who runs the System Open Market Account, said indicators are showing that reserve conditions are still abundant, noting that it's not clear at what point reserves will become scarce.
Perli, however, acknowledged that the repo market — a bellwether for showing that quantitative tightening has gone too far — pressures have been gradually increasing, citing the increased share of interdealer market transactions taking place above the interest rate on reserve balances, which is 'notably higher than it was this time last year.'
The Fed has been shrinking its holdings of debt since June 2022. It's currently allowing up to $25 billion in Treasuries and $35 billion in mortgage-backed securities to mature each month without reinvesting the returned principal. It slowed to that pace in June, after initially allowing up to $60 billion in Treasuries to run off its balance sheet each month.
Minutes from the January gathering also showed that policymakers were briefed on possible ways to structure secondary-market Treasury purchases after the end of the balance-sheet runoff. Many officials expressed support for structuring purchases in a way that moved the portfolio's composition closer to that of outstanding Treasury debt.
Currently, the SOMA Treasury portfolio is 'significantly underweight' bills and 'significantly overweight' coupon securities with 10 to 22.5 years remaining to maturity, according to Perli. He suggested the discrepancy could be addressed by allocating secondary-market purchases to T-bills, yet at a gradual pace in order to avoid impacting the markets, though this would likely take a number of years.
Portfolio Composition
Federal Reserve Bank of Dallas President Lorie Logan, a former SOMA manager, said last week it would be appropriate, in the medium term, for the US central bank to purchase more shorter-term securities than longer-term ones so that its portfolio can more quickly mirror the composition of Treasury issuance.
'The strategy I just sketched does not lock policymakers into a particular portfolio structure for the longer term — it just moves the SOMA portfolio toward a more proportionate composition in the nearer term,' Perli said. 'In the future, the committee will have the flexibility to adjust and achieve any desired portfolio composition to best support its policy objectives.'
On the Standing Repo Facility, Perli acknowledged that the addition of a morning operation on the days spanning the end of the year may have contributed to a relatively smooth conclusion to 2024 in the funding markets. He also said there's a chance the New York Fed could offer a technical exercise at the end of March, another period when short-term rate markets tend to be volatile.
According to the latest FOMC minutes, several Fed officials supported looking for ways to improve the efficacy of the Standing Repo Facility. The New York Fed has been conducting a series of small-value exercises to take place at the beginning of the trading session.
(Updates with background on debt-limit in fourth paragraph.)
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