NY Fed, Speech: Patricia Zobel SOMA Manager Pro Tem, The Ample Reserves Framework and Balance Sheet Reduction: Perspective from the Open Market Desk
“The Federal Reserve’s two main administered rates—the interest on reserve balances (IORB) rate and the offering rate on the overnight repurchase agreement (ON RRP) facility—provide strong incentives in money markets. IORB sets a benchmark against which banks evaluate their lending and borrowing opportunities. The ON RRP facility provides a soft floor for the overnight money market activity of a broader set of market participants. It supports control of the federal funds rate, in particular when the supply of reserves is abundant and the availability of alternative investments, like Treasury bills, is relatively limited. The ON RRP facility increases bargaining power for its counterparties and, when needed, broadens the holders of Federal Reserve liabilities beyond banks, easing pressures on bank balance sheets that may result from elevated reserve levels.”
“In 2021, the Committee made an important addition to the ample reserves framework by establishing a new backstop tool—the standing repo facility (SRF)—to support effective policy implementation. The SRF was established to complement the discount window and serve as a liquidity backstop to make the framework more resilient to occasional disturbances that can occur in money markets.3 The SRF is available as a backstop to address upward pressures in the repo market that can spill over to the federal funds market and, when needed, to flexibly add reserves.”
“Nonetheless, this substantial expansion in Federal Reserve liabilities since the onset of the pandemic is not a permanent feature of the framework, but a result of balance sheet policies employed to support the economy during a time of exceptional stress in financial markets and a deep economic downturn. It is the path to a smaller balance sheet that I would like to discuss next, and how the ample reserves framework can flexibly support interest rate control during this transition.”
“The Federal Reserve has prior experience reducing the size of its balance sheet. Between 2017 and 2019, the balance sheet shrank by $700 billion, and this runoff proceeded smoothly, during the period when reserves were ample. Nonetheless, there are several differences between the current environment and our prior experience. Compared with the prior period, the size of the Federal Reserve’s balance sheet is considerably larger, and the pace of runoff will be faster.14 The composition of liabilities is also different. ON RRP balances of around $2.2 trillion currently comprise about a quarter of the Federal Reserve’s liabilities. In contrast, when the prior period of balance sheet reduction began, ON RRP balances averaged less than $125 billion, accounting for only 3 percent of liabilities.”
“The relative pace at which reserves and ON RRP balances decline will depend on the actions of a broad range of money market participants. These adjustments are likely to take time to play out given the size of the ON RRP facility. While ON RRP balances may remain elevated in the near term, we are already observing modest shifts in money markets that should lead to smaller ON RRP balances over time.”
“First, as a repo market investment, the ON RRP facility’s balances are influenced by the relative yields on alternative short-term money market instruments. Over the first half of the year, a declining supply of Treasury bills and uncertainty about the path of policy put downward pressure on short-term interest rates relative to the ON RRP rate, increasing demand for the facility.”
“In the coming months, the supply of safe, short-term investments may grow. Net Treasury bill issuance has risen by about $250 billion from its trough in mid-July and is projected to rise modestly through the end of the year. This has lifted Treasury bill yields relative to other money market interest rates from the very low levels observed this summer. Over time, the faster pace of SOMA runoff may further expand the supply of alternative money market investments by increasing the amounts of Treasuries and agency MBS funded in private repo markets.”