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Implementation of Open Market Operations Simon Potter Executive Vice President, Markets Group Manager, System Open Market Account Working Group on Financial Markets of the Federal Reserve Bank of Chicago September 5, 2014 Agenda Federal Reserve’s operating framework Execution of large-scale asset purchases Implications for the Fed’s balance sheet Implications for income Implications for normalization The views expressed are the presenter’s and not those of the Federal Reserve Bank of New York or the Federal Reserve System. 2 Federal Reserve’s Operating Framework for internal use only Monetary Policy Formulation and Implementation Policy formulation Objectives established by Federal Reserve Act “Dual mandate” of maximum employment and price stability Policy implementation through open market operations (OMOs) FOMC votes on domestic policy directive ▫ Directive establishes an operating objective for OMOs Desk designs and conducts OMOs to achieve the objective ▫ SOMA Manager accountable to the FOMC ▫ Market monitoring supports policy formulation and execution Board of Governors regulates complementary policy tools Discount window (administered by Reserve Banks) Reserve requirements, interest on reserves, term deposits 4 Operating Framework for Policy Implementation Conventional operating objective for OMOs was target federal funds rate (FFR) Desk adjusted supply of reserve balances to achieve target ▫ Repos/reverse repos address transitory reserve needs ▫ Treasury purchases offset currency growth With the FFR at the effective zero bound, operating objective has shifted to adjustments in balance sheet size/composition Large-scale purchases of Treasuries, agency MBS and debt Maturity Extension Program Reinvestment policies Interest on reserves keeps FFR in target range w/o OMOs FOMC has also used communications to influence policy 5 Timeline of Asset Purchase Programs USD, billions (par) 5,000 SOMA Domestic Securities Holdings LSAP1 LSAP2 4,500 MEP LSAP3 Start of LSAP3 for agency MBS 4,000 3,500 3,000 2,500 2,000 Reinvest agency MBS/debt in MBS 1,500 1,000 500 Reinvest agency MBS/debt in Treasuries 0 Source: Board of Governors of the Federal Reserve System 6 Large-scale Asset Purchases as a Policy Tool Purchases put downward pressure on longer-term interest rates, ease financial conditions and stimulate economic activity Purchases are understood to work through several channels Portfolio balance effect ▫ Reduce stock of securities held by private sector ▫ Remove duration risk and prepayment risk from market ▫ Drive risk premiums lower than they would otherwise be Market functioning/liquidity effect (LSAP1) ▫ Provide consistent and significant market presence Signaling effect ▫ May be perceived as signal of FOMC intentions for FFR path 7 Execution of Large-scale Asset Purchases for internal use only Implications for Open Market Operations LSAPs raised new operational challenges for the Desk New, more complex instruments (agency MBS) Increased frequency and size of operations However, the fundamental approach has remained the same Carry out FOMC’s directives with efficiency and competence In doing so: ▫ ▫ ▫ ▫ ▫ Seek competitive pricing and cost efficiency Prudently manage risks Be mindful of disruptions to financial markets Be consistent, predictable and transparent Innovate and adjust operations as needed Same attention will apply to tools used during normalization 9 Treasury and Agency MBS Purchase Operations Treasuries Agency MBS longer-term Treasuries newly-issued agency MBS secondary market TBA market planned by maturity sector roughly proportional to anticipated gross issuance FedTrade Tradeweb FedTrade single maturity range multiple coupons w/in single MBS settlement class Auction Style multi-security, multi-price auction simultaneous, single-security multi-price auctions Concentration Limit 70% of individual security N/A relative value market prices market prices primary dealers primary dealers TOC pilot program completed MOC pilot program accepting applicants none dollar rolls margining regime CUSIP aggregation Design Type of Securities Market Purchase Distribution Trading Platform Operations Scope of Operation Other Counterparties Selection Criteria Standing Counterparties Small Firms Additional Considerations 10 Coupon Distribution of SOMA Agency MBS Purchases Monthly SOMA Purchases of 30-Year Agency MBS 100% 2.5% 3.0% 3.5% 4.0% 4.5% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: FRBNY 11 Agency MBS Operations in FedTrade Agency MBS operations moved to FedTrade in April 2014 Multi-year effort to expand proprietary system’s capabilities Strategic objectives were quickly realized Increase efficiency Enhance transparency Reduce operational and information security risk Dollar rolls still conducted over commercial trading platform 12 Additional Operational Considerations Market functioning Monitor effects of purchases on market conditions, results Conduct securities lending and dollar rolls Transparency Release planned operation schedules in advance Release aggregate operational results and prices paid Release summary of individual transaction details monthly Release full transaction details with a 2-year lag Operational risk management and resiliency Ensure robust controls Provide end-to-end resiliency for mission-critical operations 13 SOMA Holdings as a Share of Outstanding Supply Percent SOMA Treasury Holdings August 2014 Percent 50 50 40 40 30 30 20 20 10 10 0 0 Years to Maturity/Security Type Sources: FRBNY, U.S. Treasury Department SOMA Agency MBS Holdings August 2014 Coupon (percent) Sources: FRBNY, eMBS 14 Implications for the Fed’s Balance Sheet for internal use only Evolution of the Federal Reserve’s Balance Sheet Assets Liabilities and Capital USD, billions USD, billions 5,000 5,000 Treasuries 4,500 4,000 Agency Debt Agency MBS FR Notes 4,500 4,000 Reserve Balances Other Liabilities** + Capital Other Assets* 3,500 3,500 3,000 3,000 2,500 2,500 2,000 2,000 1,500 1,500 1,000 1,000 500 500 0 2007 2008 2009 2010 2011 2012 2013 2014 * Includes DW, crisis facilities, central bank liquidity swaps, foreign portfolio, and unamortized premiums and discounts. Source: Board of Governors of the Federal Reserve System 0 2007 2008 2009 2010 2011 2012 2013 2014 ** Includes Treasury accounts and reverse repos. 16 Distribution of SOMA Treasury Holdings SOMA Treasury Holdings by Maturity/Sector Percent 80 August 2007 August 2014 70 60 50 40 30 20 10 0 < 3 years 3-6 years 6 - 10 years 10 - 30 years TIPS FRNs Source: FRBNY 17 Distribution of SOMA Agency MBS Holdings August 27, 2014 Total = $1,678 billion (settled) Issuer Freddie Mac Fannie Mae Term* Coupon Ginnie Mae 30-year ≤2.5% Vintage Pre-2009 0% 3% 2010 2011 20% 15-year 3.5% 2012 40% ≥4% 4% 2013 60% 2014 80% 100% *Includes <1% in 10-year and 20-year agency MBS, which may be delivered into 15- and 30-year TBA contracts, respectively. Source: FRBNY 18 SOMA Portfolio Risk Measures USD, billions Duration and 10-Year Equivalents of SOMA Portfolio 3,500 Years 9 10-Year Equivalents - Total SOMA Portfolio (LHS) 3,000 Duration - SOMA Treasury Portfolio (RHS) 2,500 8 7 2,000 6 1,500 1,000 5 500 4 0 3 Source: FRBNY 19 Implications for Income for internal use only SOMA Net Income and Fed Remittances to Treasury USD, billions 100 SOMA Net Income Remittances 90 80 70 60 50 40 30 20 10 0 Source: FRBNY 21 Portfolio Projection Exercise: Baseline Assumptions July 2014 Survey of Primary Dealers (FRBNY) median results Asset purchases continue to taper, end in October 2014 FFR target lifts off in Q3-2015 Normalization framework* ▫ IOER and ON RRPs $350 billion in ON RRPs immediately after liftoff – Spread of 20 bps between IOER and ON RRP rates – ▫ Reinvestments end after FFR liftoff (Q1-2016) ▫ No MBS sales June 2014 Blue Chip Financial Forecasts Survey consensus FFR target lifts off in Q3-2015, rises to 3.8% over long run 10-year Treasury yield rises gradually to ~5% by early 2019 Currency and capital assumptions from Fed staff research** * July SPD preceded the July 29-30, 2014, FOMC meeting; minutes to this meeting reportedly led market participants to expect a wider IOER-ON RRP spread. ** Carpenter et al, “The Federal Reserve’s Balance Sheet: A Primer and Projections,” Board of Governors of the Federal Reserve System FEDS no. 2013-01, January 2013. 22 Projected Path of SOMA Domestic Securities Portfolio USD, billions 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 Historical Values Projections (rounded) 0 Source: FRBNY staff projection (August 2014) 23 Projected SOMA Net Income USD, billions 120 100 80 60 40 20 Historical Values Projections (rounded) 0 Source: FRBNY staff projection (August 2014) 24 Implications for Normalization for internal use only Normalization Tools The Fed has developed and tested tools to “normalize” policy Interest on excess reserves (IOER) Overnight reverse repos (ON RRPs) Term Deposit Facility (TDF) Term reverse repos (term RRPs) Asset sales Tools may be used towards different ends Control short-term rates with an elevated level of reserves Drain reserve balances 26 FOMC Communications on Normalization Considerable agreement on framework described in July 2014 FOMC minutes FOMC says it intends to provide more information later this year Normalizing the stance and conduct of policy FFR remains key policy rate ▫ Target range of 25 bps at liftoff and for some time thereafter IOER adjustments as primary tool to move FFR and influence other rates ON RRP facility helps firm floor under rates during normalization ▫ Facility described as temporary and limited in scale Initially, IOER rate at top of FFR range and ON RRP rate at bottom Normalizing the size and composition of the balance sheet In long run, reduce balance sheet to smallest level needed for efficiency ▫ Portfolio should consist primarily of Treasuries Reduce or end reinvestments sometime after liftoff Anticipate no MBS sales, except perhaps to eliminate residual holdings 27 FOMC Resolutions Authorizing ON RRP Exercise Through temporary resolutions, the FOMC has authorized the New York Fed to conduct a series of fixed-rate ON RRPs according to the following terms Approval Date Terms Sep 17, 2013 • • • • Fixed rate may vary from 0 to 5 basis points Maximum allotment of $1 billion/day per counterparty SOMA Manager will inform FOMC in advance of changes Operations authorized through Jan 29, 2014 Dec 17, 2013 • Maximum allotment cap raised to $3 billion/day per counterparty Jan 28, 2014 • • • Fixed rate may vary from 0 to 5 basis points No stated allotment cap per counterparty Changes in offered rate or per-counterparty bid limit requires approval of the FOMC Chair SOMA Manager will notify FOMC in advance of changes Operations authorized through Jan 30, 2015 • • 28 Secured Overnight Interest Rates Basis points 30 Treasury GCF Repo Index 25 ON RRP Fixed Rate FOMC authorizes extension of ON RRP exercise 20 15 10 5 0 Sources: FRBNY, DTCC 29 ON RRP Exercise: Operation Results ON RRP Allotment vs. Rate Spread (since $10 bn cap/counterparty) ON RRP Participation USD, billions 400 350 Month/Quarter-end Allotment (LHS) Allotment (LHS) # of bidders USD, billions 140 400 120 350 Bidders (RHS) 300 Q2-2014 end 300 100 250 250 80 200 200 60 150 150 40 100 100 50 20 50 0 0 0 -2 0 2 4 6 8 10 12 Treasury GCF Repo Index less ON RRP Rate (bps) Source: FRBNY Sources: FRBNY, DTCC 30 ON RRP Counterparties Broad set of RRP counterparties participates in exercise 140 counterparties currently eligible ▫ 22 primary dealers ▫ 118 expanded RRP counterparties 94 2a-7 money market funds (MMFs) (32 government; 62 prime) – 18 depository institutions – 6 government-sponsored enterprises – Counterparty observations All types of counterparties participate Largest take-up from money market funds (MMFs) Some bids awarded at maximum limit ▫ 64 instances since increase to $10 billion cap on April 7, 2014 31 ON RRP Exercise: Take-up by Counterparty Type USD, billions Daily Allotment in ON RRPs by Counterparty Type 350 300 MMFs FOMC authorizes extension of ON RRP exercise GSEs 250 200 Primary Dealers Banks 150 100 50 0 Source: FRBNY 32 ON RRP Exercise: Take-up by Counterparty Type Share of Total Participation in ON RRP Exercise Operations to Date MMFs-Gov 60% 49% MMFs-Prime 40% MMFs-Gov MMFs-Prime 22% GSEs 10% PDs 6% Banks 2% Non-Quarter-End Dates 7% GSEs 3% PDs 1% Banks Quarter-End Dates Source: FRBNY 33 Term Deposit Facility: Exercise Results Date Term (days) Max Award Amount (billions) Rate Size (billions) # of participants Jan 13, 2014 28 $1.25 0.26% $12.8 31 Mar 3, 2014 7 $1.25 0.26% $13.5 26 Mar 10, 2014 7 $1.25 0.26% $15.2 29 Mar 17, 2014 7 $1.25 0.26% $15.4 27 Mar 24, 2014 7 $1.25 0.26% $14.3 27 May 19, 2014 7 $3.00 0.26% $27.6 35 May 27, 2014 7 $5.00 0.26% $42.9 33 Jun 2, 2014 7 $7.00 0.26% $59.1 35 Jun 9, 2014 7 $10.00 0.26% $77.8 40 Jun 16, 2014 7 $10.00 0.27% $92.7 45 Jun 23, 2014 7 $10.00 0.28% $92.4 46 Jun 30, 2014 7 $10.00 0.29% $124.9 58 Jul 7 2014 7 $10.00 0.30% $152.8 75 34 Money Market Data Collection New data collection requirement effective April 1, 2014 Report of Selected Money Market Rates (FR 2420) Collects transaction-level data on unsecured borrowing Transaction Type Reporting Entities* Submission Frequency Federal Funds U.S. banks and thrifts, FBO branches Daily, previous day’s transactions by 7:00 am Eurodollars U.S banks and thrifts Daily, previous day’s transactions by 7:00 am Certificates of Deposits U.S. banks and thrifts, FBO branches Daily, activity from two days prior by 2:00 pm * U.S. banks with > $26 billion in assets report the activity of their U.S. operations and foreign branches with > $2 billion in assets. FBO branches with > $900 million in third-party assets each report separately. 35 Questions for internal use only