Fed Says Bond Purchases Didn’t Disrupt Markets in 2012Joshua Zumbrun
The Federal Reserve Bank of New York said the Fed’s asset purchase programs, including the $667 billion Operation Twist and $40 billion in monthly mortgage bond purchases, didn’t disrupt financial markets last year.
The central bank’s open market desk “closely monitored market conditions; its activity did not have significant adverse effects on market functioning,” the New York Fed said in an annual report on the System Open Market Account portfolio released today. The New York Fed executes monetary policy by buying and selling bonds in the account.
The Fed’s balance sheet has climbed to a record $3.2 trillion, prompting central bank officials to monitor markets to ensure asset purchases don’t impair other transactions. The Federal Open Market Committee is assessing the risks and benefits of bond buying, with Chairman Ben S. Bernanke saying on Feb. 27 he saw no “significant problems” in markets from $85 billion in monthly purchases.
“We really have some of the best functioning financial markets since the crisis,” said Thomas Simons, money market economist in New York at Jefferies LLC, a primary dealer that trades directly with the Fed. “Even though the Fed has absorbed a tremendous amount of Treasuries and MBS, I don’t see any evidence they’re having a negative effect on market function.”
The FOMC said last month it plans to continue the purchases until the labor market improves “substantially.” Last week’s Labor Department report showing the economy generated 88,000 jobs in March, the fewest in nine months, highlights that officials haven’t reached their objective, Simons said.
“Clearly the Fed’s falling short of achieving its goal on the employment side,” he said. Smooth market functioning and a labor market weakness is “going to allow them to continue down the path on the current policy, to continue purchases.”
Today’s New York Fed report covers the year 2012, during which the central bank concluded its Operation Twist program in which it swapped about $45 billion a month of short-term Treasury securities for longer-term government debt, in an effort to lower interest rates. In September, the Fed began purchasing $40 billion a month of mortgage-backed securities, to further support the housing market.
“Common metrics of market functioning suggested that the Desk’s MBS purchase operations did not have any significant adverse effects on the MBS market in 2012,” the Fed said in the annual report. “Trading volumes remained near longer-term averages, while settlement fails in the agency MBS market declined to, and then remained near, multiyear lows.”
New York Fed President William C. Dudley said in a March 25 speech that “market functioning has actually improved in recent months” by some metrics.
“Of course, we will need to continue to monitor this, particularly if a rise in interest rates leads to less MBS issuance,” he said. “But so far, so good.”
The yield on the 10-year Treasury note traded below 2 percent for the third straight week as Bernanke signaled in a speech yesterday that there was room for improvement in the economy, spurring bets the central bank will maintain asset purchases. Benchmark 10-year Treasury note yields were 1.74 percent at 1:44 p.m., down 0.06 percentage point.
The report primarily summarizes the asset-purchase programs and documents how they’ve changed the composition of the Fed’s portfolio. The securities portfolio run by the New York Fed comprises the bulk of the central bank’s balance sheet. At the end of 2012, the portfolio stood at $2.8 trillion.
The New York Fed said that, based on its survey of primary dealers, the asset portfolio will reach a peak of $3.9 trillion in 2014. The portfolio will begin “declining steadily for more than four years” in 2015, as the Fed sells securities or allows them to mature and roll-off.
The report also included an analysis of whether the Fed will continue to earn large profits that it then returns to the Treasury. Previous Fed research has shown that those profits could disappear as interest rates rise.
The report said in some scenarios income could disappear. “A temporary reduction in income, which could prompt a halt to remittances to the Treasury, would not affect the Desk’s capacity to conduct open market operations or the FOMC’s ability to manage short-term interest rates,” the Fed said.