New York Fed officials: Initial signs of tightening in the money market, pressure from the Federal Reserve's balance sheet reduction becoming apparent

According to the Zhitong Finance APP, officials responsible for managing the large securities investment portfolio at the Federal Reserve Bank of New York have stated that the Fed's efforts to reduce its balance sheet have begun to exert pressure on the repurchase agreement market.

Roberto Perli, the manager of the New York Fed's Open Market Account, noted in a prepared speech on Thursday that this pressure may mean that the Fed's tools for controlling short-term interest rates will become increasingly important. He stated at an event co-hosted by the New York Fed and Columbia University's School of International and Public Affairs (SIPA) that as the Fed's balance sheet continues to shrink, bank reserves are shifting from "ample" to "adequate" levels, which may exacerbate upward pressure on money market rates.

Perli stated that fluctuations in money market rates "represent a normalization of liquidity conditions and should not be a cause for concern." However, he added that this does indeed mean that "the role of the Standing Repo Facility (SRF) in interest rate control may be more critical in the future than it has been recently."

Since June 2022, the Fed has been reducing its bond holdings. Last month, policymakers slowed the pace of asset reduction, lowering the monthly cap on maturing U.S. Treasury securities that are allowed to roll off from $25 billion to $5 billion, while maintaining the cap on mortgage-backed securities at $35 billion.

Fed officials and investors are closely monitoring the amount of cash banks hold at the central bank to determine when to stop the balance sheet reduction (i.e., quantitative tightening, QT). An increase in cash on hand indicates greater liquidity in the system, allowing the Fed to extend the QT process.

Recent data shows that as of the week ending May 14, the Fed's balance sheet stood at $3.24 trillion, up from $3 trillion the previous week, and slightly below the level when QT was initiated nearly three years ago. Wall Street strategists estimate that to maintain adequate liquidity and avoid market pressure, the Fed needs to keep its balance sheet above $3 trillion to $3.25 trillion.

Standing Repo Facility (SRF)

Perli acknowledged that the SRF (which allows eligible banks and primary dealers to borrow overnight using U.S. Treasuries and agency debt as collateral at a rate set by the Fed) helps reduce the amount of reserves the central bank needs to provide to maintain effective operations under the "adequate reserves framework."

"The smoother the operation of this tool, the more significant its effects, and the lower the reserve buffer needed to address the inherent uncertainties in the implementation of monetary policy," Perli stated.

Earlier this month, Perli mentioned that the New York Fed plans to incorporate SRF early settlement operations into its regular schedule to support smooth market functioning. Even before the bond market volatility last month, the agency had begun offering additional daily repo operations—these operations are scheduled for periods such as the end of December 2024 and the end of March, when repo rates tend to spike due to banks reducing their business scale for regulatory purposes.

Perli pointed out that although the SRF is an "important tool," there are some factors that hinder counterparties from using it. Officials are looking for ways to address these obstacles, including the inability of dealers to net settle these transactions off their balance sheets and uncertainties in allocation limits "These frictions increase the cost for counterparties to use the tool, meaning that counterparties typically require private market repurchase rates to be significantly higher than the minimum bidding rate of the SRF before they will use the tool," he stated, noting that these frictions have already emerged by December 2024