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WASHINGTON (MNI) - The following is an excerpt from the Federal Open 
Market Committee minutes of the April 30 - May 1 meeting, published 
     Participants resumed their discussion of issues related to balance 
sheet normalization with a focus on the longrun maturity composition of 
the System Open Market Account (SOMA) portfolio. The staff presented two 
illustrative scenarios as a way of highlighting a range of implications 
of different long-run target portfolio compositions. In the first 
scenario, the maturity composition of the U.S. Treasury securities in 
the target portfolio was similar to that of the universe of currently 
outstanding U.S. Treasury securities (a proportional portfolio). In 
the second, the target portfolio contained only shorterterm securities 
with maturities of three years or less (a shorter maturity portfolio). 
The staff provided estimates of the capacity that the Committee would 
have under each scenario to provide economic stimulus through a maturity 
extension program (MEP). The staff also provided estimates of the extent 
to which term premiums embedded in longer-term Treasury yields might be 
affected under the two different scenarios. Based on the staffs 
standard modeling framework, all else equal, a move to the illustrative 
shorter maturity portfolio would put significant upward pressure on term 
premiums and imply that the path of the federal funds rate would need to 
be correspondingly lower to achieve the same macroeconomic outcomes as 
in the baseline outlook. However, the staff noted the uncertainties 
inherent in the analysis, including the difficulties in estimating the 
effects of changes in SOMA holdings on longer-term interest rates and 
the economy more generally. 
     The staff presentation also considered illustrative gradual and 
accelerated transition paths to each long-run target portfolio. Under 
the illustrative gradual transition, reinvestments of maturing 
Treasury holdings, principal payments on agency mortgage-backed 
securities (MBS), and purchases to accommodate growth in Federal Reserve 
liabilities would be directed to Treasury securities with maturities in 
the long-run target portfolio. Under the illustrative accelerated 
transition, the reinvestment of principal payments on agency MBS and 
purchases to accommodate growth in Federal Reserve liabilities would be 
directed to Treasury bills until the weighted average maturity (WAM) of 
the SOMA portfolio reached the WAM associated with the target portfolio. 
Depending on the combination of long-run target composition and the 
transition plan for arriving at that composition, the staff reported 
that, in the illustrative scenarios, it could take from 5 years to more 
than 15 years for the WAM of the SOMA portfolio to reach its longrun 
     In its Statement Regarding Monetary Policy Implementation and 
Balance Sheet Normalization, the Committee noted that it is prepared to 
adjust the size and composition of the balance sheet to achieve its 
macroeconomic objectives in a scenario in which the federal funds rate 
is constrained by the effective lower bound. Against this backdrop, 
participants discussed the benefits and costs of alternative long-run 
target portfolio compositions in supporting the use of balance sheet 
policies in such scenarios. 
     In their discussion of a shorter maturity portfolio, many 
participants noted the advantage of increased capacity for the Federal 
Reserve to conduct an MEP, which could be helpful in providing policy 
accommodation in a future economic downturn given the secular decline in 
neutral real interest rates and the associated reduced scope for 
lowering the federal funds rate in response to negative economic shocks. 
Several participants viewed an MEP as a useful initial option to address 
a future downturn in which the Committee judged that it needed to employ 
balance sheet actions to provide appropriate policy accommodation. 
Participants acknowledged the staff analysis suggesting that creating 
space to conduct an MEP by moving to a shorter maturity portfolio 
composition could boost term premiums and result in a lower path for the 
federal funds rate, reducing the capacity to ease financial conditions 
with adjustments in shortterm rates. A number of participants noted, 
however, that the estimates of the effect of a move to a shortermaturity 
portfolio composition on the long-run neutral federal funds rate are 
subject to substantial uncertainty and are based on a number of strong 
modeling assumptions. For example, estimates of term premium effects 
based on experience during the crisis could overstate the effects that 
would be associated with a gradual evolution of the composition of the 
SOMA portfolio. In addition, a shift in the composition of the SOMA 
portfolio could result in changes in the supply of securities that would 
tend to offset upward pressure on term premiums. Nonetheless, other 
participants expressed concern about the potential that a shorter 
maturity portfolio composition could result in a lower long-run neutral 
federal funds rate. Moreover, while a shorter maturity portfolio would 
provide substantial capacity to conduct an MEP, some participants raised 
questions about the effectiveness of MEPs as a policy tool relative to 
that of the federal funds rate or other unconventional policy tools. 
These participants noted that, in a situation in which it would be 
appropriate to employ unconventional policy tools, they likely would 
prefer to employ forward guidance or large-scale purchases of assets 
ahead of an MEP. In the view of these participants, the potential 
benefit of transitioning to a shorter maturity SOMA composition in terms 
of increased ability to conduct an MEP might not be worth the potential 
     In their discussion of a proportional portfolio composition, 
participants observed that moving to this target SOMA composition would 
not be expected to have much effect on current staff estimates of term 
premiums and thus would likely not reduce the scope for lowering the 
target range for the federal funds rate target in response to adverse 
economic shocks. As a result, several participants judged the 
proportional target composition to be well aligned with the Committees 
previous statements that changes in the target range for the federal 
funds rate are the primary means by which the Committee adjusts the 
stance of monetary policy. In addition, several participants noted that 
while the staff analysis suggested a proportional portfolio would not 
contain as much capacity to conduct an MEP as a shorter maturity 
portfolio, it still would contain meaningful capacity along these lines. 
Some participants noted that a proportional portfolio would also help 
maintain the traditional separation between the Federal Reserves 
decisions regarding the composition of the SOMA portfolio and the 
maturity composition of Treasury debt held by the private sector. 
However, a number of participants judged that it would be desirable to 
structure the SOMA portfolio in a way that would provide more capacity 
to conduct an MEP than in the proportional portfolio. In addition, a 
couple of participants noted that a shorter maturity portfolio would 
maintain a narrow gap between the average maturity of the assets in the 
SOMA portfolio and the short average maturity of the Federal Reserves 
primary liabilities. 
     Participants also discussed the financial stability implications 
that could be associated with alternative long-run target portfolio 
compositions. A couple of participants noted that a proportional 
portfolio could imply a relatively flat yield curve, which could result 
in greater incentives for reach for yield behavior in the financial 
system. That said, a few participants noted that a shorter maturity 
portfolio could affect financial stability risks by increasing the 
incentives for the private sector to issue short-term debt. A couple of 
participants judged that financial market functioning might be adversely 
affected if the holdings in the shorter maturity portfolio accounted for 
too large a share of total shorter maturity Treasury securities 
     In discussing the transition to the desired long-run SOMA portfolio 
composition, several participants noted that a gradual pace of 
transition could help avoid unwanted effects on financial conditions. 
However, participants observed that the gradual transition paths 
described in the staff presentation would take many years to complete. 
Against this backdrop, a few participants discussed the possibility of 
following some type of accelerated transition, perhaps including sales 
of the SOMAs residual holdings of agency MBS. In addition, several 
participants suggested that the Committee could communicate its plans 
about the SOMA portfolio composition in terms of a desired change over 
an intermediate horizon rather than a specific long-run target. 
     Several participants expressed the view that a decision regarding 
the long-run composition of the portfolio would not need to be made for 
some time, and a couple of participants highlighted the importance of 
making such a decision in the context of the ongoing review of the 
Federal Reserves monetary policy strategies, tools, and communications 
practices. Some participants noted the importance of developing an 
effective communication plan to describe the Committees decisions 
regarding the long-run target composition for the SOMA portfolio and the 
transition to that target composition. 
     ** MNI Washington Bureau: (202)371-2121 ** 
[TOPICS: MMUFE$,M$U$$$,MT$$$$]