Federal Reserve Survey: Respondents expect RMP to purchase approximately $220 billion in short-term U.S. Treasury bonds over the next 12 months

According to a survey by the Federal Reserve, as part of efforts to alleviate pressure in the money market, the scale of reserve management purchases (RMP) by the Federal Reserve is expected to exceed $200 billion over the next 12 months.

The Federal Reserve decided to begin purchasing short-term U.S. Treasury bills (T-bills) at its meeting on December 9-10. They believe that the level of reserves in the financial system has fallen to "only adequate" levels, as reflected in the rising costs of short-term financing. Although bank reserve levels may fluctuate over time, cash demand often increases at the end of the month and quarter when tax payments and other settlements are due.

In the minutes of the December FOMC meeting released by the Federal Reserve on Tuesday, it was stated: "Although there is considerable variation in respondents' estimates of the expected purchase scale, on average, respondents expect net purchases to be around $220 billion in the first 12 months following the initiation of purchases."

The Federal Reserve indicated that it will initially purchase short-term U.S. Treasury bills at a scale of about $40 billion per month, and then gradually reduce the purchase scale. As of now, the Federal Reserve has purchased approximately $38 billion in short-term U.S. Treasury bills this month and will conduct two more operations in January.

Federal Reserve policymakers emphasized that these purchases are merely a tool for managing reserves and are not the same as the Federal Reserve's broader monetary policy stance or efforts to stimulate the economy.

The latest minutes from the Federal Reserve's meeting show that prior to making this decision, some participants noted that the speed of the rise in money market rates relative to the Federal Reserve's administered rates was faster than during the balance sheet reduction period from 2017 to 2019.

Due to signs of stress in the $12.6 trillion repurchase agreement (repo) market, the Federal Reserve halted its process of reducing its asset holdings earlier this month, a process known as quantitative tightening (QT). The increase in the issuance of short-term U.S. Treasury bills since the summer, combined with the ongoing QT, is draining cash from the money market, consuming the Federal Reserve's primary liquidity tools, and pushing up short-term rates.

The related concern is that insufficient liquidity could disrupt the critical "pipeline system" in financial markets, weaken the Federal Reserve's control over interest rate policy, and in extreme cases, force market participants to liquidate positions, thereby spreading shocks to the broader U.S. Treasury market, which serves as a benchmark for global borrowing costs.

The minutes from the Federal Reserve's December meeting also recorded discussions among Federal Reserve officials on how to define and target an appropriate level of bank reserves in the system. Some participants pointed out that, given the potential for changing demand, it may be more attractive to focus on the level of money market rates relative to the rate on reserve balances rather than setting a specific reserve quantity.

An important benchmark rate linked to the overnight financing market—the Secured Overnight Financing Rate (SOFR)—was set at 3.77% on December 29, according to data released by the New York Fed on Tuesday, which is 12 basis points higher than the rate paid by the Federal Reserve on reserve balances The minutes state: "Several participants believe that if the definition of 'adequate reserves' leads to a supply of reserves exceeding the level required by the implementation committee's policy framework, it may trigger excessive risk-taking behavior by highly leveraged investors."

Some Federal Reserve officials also suggested that the standing repo facility could play a more active role as a liquidity backstop in interest rate control and allow the Federal Reserve to maintain a smaller balance sheet on average. However, some officials expressed a preference for relying on Reserve Management Purchases (RMP).

Despite a recent increase in the use of the Federal Reserve's standing repo facility, market participants remain resistant to officials encouraging more use of this tool, partly due to the negative implications of borrowing directly from the Federal Reserve