ROI-Fed could surprise market with T-bill buying binge: McGeever

By Jamie McGeever

ORLANDO, Florida, Dec 9 (Reuters) - The Federal Reserve is widely expected to trim interest rates on Wednesday, but if Chair Jerome Powell wants to give markets an added holiday surprise, here's one option: about $45 billion of monthly short-term bill purchases.

That's the out-of-consensus call from Bank of America's rates strategists. They agree that a quarter-percentage-point reduction in the Fed funds target range to 3.50%-3.75% is likely. They also reckon the Fed will announce it will start buying large quantities of Treasury bills in January to maintain "ample" reserves in the banking system and avert the kind of liquidity crunch that froze money markets in September 2019.

Bank reserves peaked at $4.27 trillion in 2021, and have recently fallen as low as $2.83 trillion.

To be clear, these so-called "Reserve Management Purchases" (RMP) would not be quantitative easing.

That refers to central bank purchases of government bonds to lower longer-dated yields and stimulate lending. Crucially, QE is usually conducted in an economy where deflation is a greater threat than inflation, and when interest rates are at or near zero.

The RMP operation that BofA envisages doesn't meet any of these criteria. It would be designed to manage money market liquidity, ensuring the plumbing of the interbank market doesn't suddenly clog up and imperil the functioning of the financial system.

However, the Fed would leave itself open to accusations from its raft of critics that, regardless of the name, this is just the latest wave of money-printing madness that could accelerate the march towards higher inflation and currency debasement.

But given ongoing concern about tightening liquidity in the repo market and a sharp rise in Treasury bill issuance by President Donald Trump's administration, this is a holiday gift that both markets and the White House might be glad to receive.

'CERTAINTY AND CONFIDENCE'

This plan wouldn't come out of left field. Most Fed-watchers already expect the central bank to begin buying bills in the first half of next year, and the Fed has already announced in October that it will redirect proceeds from its maturing mortgage-backed securities (MBS) into bills. Analysts estimate MBS reinvestments will amount to around $15 billion a month.

But BofA's call is notable both for the timing and the size of the predicted purchases. The $45 billion haul would be on top of the MBS reinvestments, meaning the Fed would soon be buying around $60 billion of bills a month.

This will provide market participants with "certainty and confidence" that reserves will remain "ample", according to BofA rates strategist Mark Cabana, who previously worked on the New York Fed's trading desk.

No one knows exactly how low reserves can get before triggering a liquidity crisis and a spike in interbank borrowing costs. But in September 2019 it was around $1.4 trillion, which was roughly 6.5% of GDP at the time.

Padhraic Garvey at ING also reckons the Fed could announce it will increase bank reserves by adding to the MBS roll-off bill purchases.

As Garvey notes, if the Fed wants to keep the balance sheet steady as a share of GDP, it will ultimately have to re-expand at the same pace as nominal GDP growth. So if nominal GDP is growing at 3-5%, bank reserves would need to increase at that rate, which would equate to the Fed buying around $20-30 billion of bills per month.

THE FED'S SHRINKING BALANCE SHEET

The Fed certainly has room to expand its balance sheet, especially at the ultra-short end of the maturity spectrum. The central bank's balance sheet stands at around $6.5 trillion, down from a peak of $9 trillion in 2022. As a share of GDP, which is the more relevant measure, it is now around 22%, down from a peak of 35% also in 2022, and the smallest it's been since April 2020.

Perhaps more importantly, bills only account for around 16% of the Fed's balance sheet, roughly the same level as just before the repo market crisis of September 2019.

Another 25-basis-point rate cut on Wednesday would be a surprise to no one. If there are any fireworks from the Fed's policy decision, they are more likely to be on the balance sheet.

(The opinions expressed here are those of the author, a columnist for Reuters)

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(By Jamie McGeever; Editing by Marguerita Choy)