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11 29 2015 | by Victor Xing | Capital Markets

Is the Federal Reserve able to directly purchase T bills?

Section 14.2(b) of the Federal Reserve Act mandates that the FED can only purchase Treasury bills (T bills), notes and bonds in the open market.  This rules out the FED directly buying securities from the U.S. Treasury (i.e. without an intermediary such as primary dealers).  However, this doesn’t mean the New York Fed’s trading desk cannot buy Treasury securities at auction.

Purchase and sale of obligations of United States, States, counties, etc.
(b)

  1. To buy and sell, at home or abroad, bonds and notes of the United States, bonds issued under the provisions of subsection (c) of section 4 of the Home Owners’ Loan Act of 1933, as amended, and having maturities from date of purchase of not exceeding six months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, and obligations of, or fully guaranteed as to principal and interest by, a foreign government or agency thereof, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the Federal Reserve System. Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market.
  2. To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.

There are additional considerations, and the Federal Reserve Board of Governors has stated at various points in its FAQ to elaborate its stance on Treasury purchases (please seehere and here).  Yet, there is one current rule that allows the New York Fed to buy Treasuries at auction – enter the Agency MBS Reinvestment Purchases and Treasury Rollovers program.  The program’s purpose is to reinvest principal payments of MBS and maturing Treasury securities in order to maintain the size of FED’s balance sheet (shrinking balance sheet is a form of monetary tightening)

FED’s balance sheet (blue line)

FED balance sheet and potential T bills purchases

The New York Fed specified that the maturity Treasury securities on FED’s balance sheet will be reinvested into newly issued Treasury securities at auction.  This means the Federal Reserve Bank of New York will participate in Treasury auctions to buy Treasury securities, including T bills, with primary dealers as intermediary (otherwise it would not qualify as buying in the “open market” and risk violating the Federal Reserve Act).

How will the Desk manage the SOMA’s maturing Treasury securities?
As directed by the FOMC, the Desk is rolling over maturing Treasury securities at auction. However, for operational efficiency, when the proceeds received by the SOMA from Treasury securities that mature on a given day total less than $2 million, the Desk will allow those securities to mature without reinvestment.

For example, if on a given date the SOMA holds two Treasury coupon securities maturing with balances of $0.5 million and $1.1 million, the full $1.6 million would be allowed to mature without reinvestment. However, if the balances of the maturing securities on that date were instead $0.5 million and $1.6 million, the full $2.1 million would be reinvested into newly issued Treasury coupon securities at auction.

As announced on January 13, 2014, Treasury Floating Rate Notes will be treated in a similar manner to other Treasury securities in its reinvestment of proceeds received from maturing Treasury security holdings

Therefore, for as long as the Federal Reserve maintains the stance against debt monetization, it will only use its balance sheet to buy Treasury securities under specific policy mandates (such as the SOMA principal reinvestment program).  The amount of purchase under such programs are very modest relative to the U.S.’ funding needs, therefore the U.S. will still need foreign countries to buy Treasury securities such as T-bills at Treasury auctions.

Below is a snapshot of the most recent 7 year Treasury note auction:

T bills auction

Next article11 29 2015 | by Victor Xing | Central Banks

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