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In his first speech as manager of the New York Federal Reserve’s System Open Market Account — where all its bond purchases are housed — Roberto Perli said that the run-off has gone “smoothly”.
And to be fair, SOMA has shunk by over $1tn since June 2022 but reserves still seem to be abundant? Despite the recent Treasury sell-off everything has looked pretty orderly, and the NY Fed’s ON RRP and IORB tools have helped keep the fed funds rate where the central bank wants it to be.
But Perli admitted that the transition from the post-GFC “abundant reserves” era to the Fed’s desired “ample reserves” could still prove bumpy, given that the central bank doesn’t actually know when one state ends and the other begins (if it gets tight we’ll know pretty quickly as something will break).
Here is the speech he delivered yesterday evening, with Alphaville’s emphasis below:
At some yet unknown point in the future, reserves will approach a level beyond which the FOMC would prefer to not allow further declines. We are cognizant of the challenges that transition can present, and the experience of September 2019 exemplifies them well. At that time, a confluence of factors contributed to a scarcity of reserves that put considerable pressure on short-term interest rates. That episode has been the subject of extensive discussion and analysis which I will not review here [ed note: the FT did a great job here]. But, although the current situation is different in several ways, it is worth reflecting on the policy implementation lessons that can be drawn from that experience.
First, as noted earlier, demand for reserves is not static. Indeed, it can be highly variable and difficult to observe in real time, and even more difficult to forecast.
Second, demand for reserves is not only time-varying but also non-linear. That means that under some circumstances, small changes in the quantity of reserves can generate a large change in federal funds rates relative to administered rates.
These two considerations argue strongly in favor of a floor system and are also the reason why the FOMC has indicated its intention to slow and stop balance sheet runoff when reserve balances are somewhat above the ample region. We know that the transition from abundant to ample will occur at some point, but we don’t know when. For now, that moment does not seem to be on the horizon.
Here are the main things that Perli said the NY Fed’s markets desk in its “constant vigilance” was watching for signs that reserves were getting uncomfortably tight again.
Spreads of private overnight market rates relative to administered rates;
The relationship between those spreads and changes in reserve balances;
The composition of borrowers in fed funds and other money markets;
Changes in advance demand from FHLB member banks;
The distribution of reserve balances.
Is anyone seeing any hints that money markets are tighter than the Fed thinks?
Source: Economy - ft.com
