The Changing Composition of the Fed’s Balance Sheet
With the traditional tools of U.S. monetary policy sidelined in importance by the financial crisis, the Fed’s balance sheet has become the focus of attention for those following the central bank’s efforts to influence the economy and restore the functioning of credit markets. Since the onset of the crisis, the Fed has created and employed a new set of tools that involve the acquisition of financial assets and thus expand the asset side of the balance sheet.
While the sheer volume of assets acquired can be influential, the particular composition of those assets can have effects as well. By changing the mix of the assets it holds, the Fed is able to more effectively provide liquidity to troubled markets. Lending to financial institutions predominated in the early months after the crisis began, but large-scale asset purchases will be the bigger story going forward.
The unwinding of several lending facilities and the uptick in liquidity markets have caused large portions of the balance sheet to contract. In fact, since mid-March of this year, lending to financial institutions and key credit markets went from making up over 70 percent of the total balance sheet to constituting just under 30 percent of it. This contraction reflects improvement in the banking sector and in short-term securities markets. All of this occurred while the total value of the balance sheet remained fairly constant, growing less than one half of a percentage point over the same time period. The difference has been filled by growth in the large-scale asset purchase programs. They have gone from comprising just over 13 percent of the balance sheet to comprising a little less than 50 percent. With this trend predicted to continue through the end of the year, it is important to understand the newest focal point of Federal Reserve monetary policy.
Long-term Treasury purchases were announced on March 18 of this year and have been climbing steadily. As of now, purchases are slightly ahead of the original pace that would achieve the purchase limit of $300 billion by autumn (about $10.7 billion each week). At this point, the average weekly purchase has been $11.7 billion, meaning that an average of only $3.5 billion can be purchased each week for the remainder of the program if the maximum stated allotment is to be met. The FOMC recently decided to taper off the purchases to reduce any ill effects that the Fed’s removal from the Treasury market may have. For that reason, the goal of $300 billion has been reset to expire at the end of October, and purchases will climb to that threshold at a decreasing rate from this point forward. This decision is intended to promote a more independent Treasury market, which will be utilized by more liquid investors.
Purchases of mortgage-backed securities (MBS) have been growing at a steady rate of around $23.4 billion per week. The plan to purchase MBS was announced in November of last year, but it was originally set to acquire up to $500 billion worth of securities over the course of several quarters. When long-term Treasury purchases were announced in March, an additional $750 billion was allotted for MBS purchases, and the deadline was set for the end of the year. If the Federal Reserve made regular acquisitions from the start of the program to the end of the suggested period, they would need to purchase an average of $24.5 billion each week. With purchasing having fallen slightly behind this schedule, the Federal Reserve would need to increase its average weekly purchase to $26.6 billion to achieve the allotment by the end of the year. Signs of a recovery in the market can be seen in the rise in issuances of these securities, as well as a smaller percentage of these issuances being purchased by the Federal Reserve each month.
Purchases of government-sponsored enterprise (GSE) or “agency” debt are scheduled to hit their limit by the end of the year. November of last year marked the initial appropriation of $100 billion, with an additional $100 billion appropriated in March of this year. Again, using a simple analysis, if the Federal Reserve were to make regular purchases over this span, it would average $3 billion in purchases each week. To date though, the weekly average has been only $2.4 billion, leaving this program on track to be completed only by mid-April of next year, a full quarter behind schedule. The Federal Reserve would have to ramp up weekly purchases substantially to make up for the slow pace and still meet the original deadline.