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Fed Will Purchase Treasury Bills at Least Into Second Quarter of 2020 -- 2nd Update

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10/11/2019 | 03:59pm EDT

By Nick Timiraos and Paul Kiernan

The Federal Reserve said Friday it would buy short-term Treasury debt beginning next week to avoid a recurrence of the unexpected strains experienced in money markets last month.

The Fed will buy Treasury bills beginning next Tuesday at an initial pace of $60 billion a month and continue those purchases into the second quarter of 2020.

The announcement marks a U-turn for the central bank, which until August had been shrinking its nearly $4 trillion asset portfolio.

The Fed said the actions were "purely technical measures to support the effective implementation" of the rate-setting committee's policy "and do not represent a change in the stance of monetary policy."

Fed officials stopped shrinking the assets on their balance sheet this summer but never said when they would allow them to grow again. As a result, a crucial liability on the balance sheet -- bank deposits held at the Fed, called reserves -- has continued to decline.

Stresses in very-short-term funding markets last month suggested banks had grown reluctant to lend those reserves and that the Fed may have allowed them to fall too low.

Reserves dropped to less than $1.4 trillion last month, from $2.8 trillion in 2014, when the Fed stopped buying assets. Most of the decline occurred over the past two years after the Fed pared its asset holdings by allowing some bonds to mature without replacing them.

The Fed said its goal will be to rebuild the level of reserves in the system to levels of nearly $1.5 trillion that prevailed in early September.

"This is a much needed bazooka from the Fed," said Mark Cabana, head of U.S. interest rates at Bank of America Corp. "It shows the Fed is finally doing what is necessary to correct their mistake from dropping reserves too low."

Changes in how the Fed administers its rate decisions and in bank regulation earlier this decade, along with increased government debt issuance over the past year, have made it harder for the Fed to determine how many reserves it could drain from the system.

"We're in a period of time where the Fed and others are in a learning-by-doing mode," said Ward McCarthy, chief financial economist at financial-services company Jefferies LLC. "They have been making the right adjustments and, just as important, they are being very transparent about it."

Fed Chairman Jerome Powell hinted at the announcement in a speech Tuesday. He said the Fed's funding plan would be designed to maintain a firm grip on very-short-term lending rates and not to provide economic stimulus.

The Fed bought longer-dated Treasury and mortgage securities in successive stimulus campaigns between 2008 and 2014 that became known as quantitative easing, or QE.

"This is not QE," Mr. Powell said Tuesday. "In no sense is this QE."

Rather than purchase longer-dated securities, officials will instead buy shorter-dated Treasury bills. Officials believe holding long-term securities boosts the economy and financial markets by lowering long-term rates and driving investors into stocks and bonds. They think a portfolio weighted toward shorter-term securities provides less or no stimulus.

The Fed's rate-setting Federal Open Market Committee met by videoconference Oct. 4 to discuss recent developments in money markets. It voted unanimously to approve the plans announced Friday.

The committee last met on Sept. 17-18, as the spike in overnight funding markets occurred. Their next scheduled meeting is Oct. 29-30.

The committee last made a policy change between its regularly scheduled policy meetings in May 2010, when it reopened a lending program with foreign central banks to alleviate funding pressures growing out of Europe's fiscal crisis.

Last month's spike in overnight funding markets led the Fed's benchmark rate to trade outside of its range for one day. While the Fed quickly fixed the problem after it occurred, the funding-market dysfunction dinged the Fed's reputation among some interest-rate traders and raised questions over the central bank's strategy for its balance sheet.

The episode also followed a period in which New York Fed President John Williams dismissed the head of the bank's markets desk, which oversees the balance sheet. He has yet to name a successor.

The Fed's balance sheet has swelled to nearly $4 trillion from $3.8 trillion over the past month because the New York Fed has been conducting temporary overnight and short-term lending operations to restore liquidity to markets for very-short-term loans that banks make to each other overnight, called repurchase or "repo" agreements.

The Fed also said Friday it would continue to lend in repo markets through January of next year. It will initially offer at least $35 billion of multiday repo operations, generally twice a week. Overnight repo operations will take place daily, initially in an offering amount of at least $75 billion per operation, the Fed said.

The Fed has been purchasing up to $20 billion of a range of Treasury securities since August to replace maturing mortgage securities. The $60 billion of monthly bill purchases announced Friday will be added to those purchases.

Write to Nick Timiraos at nick.timiraos@wsj.com and Paul Kiernan at paul.kiernan@wsj.com

Stocks mentioned in the article
ChangeLast1st jan.
BYD COMPANY LIMITED -1.47% 43.5 End-of-day quote.11.97%
DEERE & COMPANY -0.68% 152.12 Delayed Quote.-11.60%
LETS HOLDINGS GROUP CO., LTD. 4.01% 12.45 End-of-day quote.106.13%
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