The Federal Reserve Bank of New York (FRBNY) today announced several changes in the way it will manage the Federal Reserve System’s portfolio of Treasury securities. These changes are intended to help the FRBNY to manage the liquidity and average maturity of the System Open Market Account (SOMA) over coming quarters in light of recent and anticipated changes in the quantity and composition of marketable Treasury securities. The Manager of the SOMA has reviewed these changes with the Federal Open Market Committee (FOMC) and they will remain in place while the Federal Reserve undertakes a thorough review of alternatives for open market operations in this environment.
The FRBNY has already begun to cap the amount of the SOMA’s holdings of Treasury bills at 35 percent of any given issue, both in terms of what will be rolled over at each auction and in terms of acquisitions in the secondary market. The SOMA’s holdings of Treasury coupon issues now also will be capped in a similar manner on a graduated scale from 25 percent for two-year notes down to 15 percent for coupon securities with maturities of 10 years or more.
A key objective of the FOMC has been to maintain a relatively short and liquid portfolio to enable the System to deal readily with any contingencies that might arise in the course of managing the reserve base. However, in recent years the average maturity of the SOMA portfolio has lengthened from 2.6 years in 1992 to 4.2 years today. The changes announced today are designed to help limit any further lengthening of the average maturity of the SOMA.
These changes in Federal Reserve operations have been developed in consultation with the Department of the Treasury. The public announcement of these changes is intended to help market participants to anticipate Federal Reserve operations in the face of changes in the quantity and composition of outstanding Treasury debt.
Auction participation. Until now, the FRBNY routinely has rolled over the SOMA holdings of Treasury securities into new issues. In Treasury auctions, the FRBNY has placed non-competitive bids for the SOMA, treated by the Treasury as "add-ons" to the publicly–announced auction amounts, equal to the SOMA’s holdings that mature on the auction settlement date.
The FRBNY henceforth will modify this procedure to avoid the SOMA holding an ever-larger share of newly-issued securities. Going forward, the FRBNY will place add-on bids for the SOMA equal to the lesser of (a) the SOMA’s maturing holdings on the issue date of a new security, or (b) a fixed percentage of the total amount (including SOMA holdings) to be issued of that new security.
Continuation of the current practice of rolling over the full amount of the SOMA’s maturing holdings, while sizes of new Treasury issues decline, would result in the Federal Reserve acquiring an increasingly larger share of new issues. However, the Federal Reserve has no portfolio need for the particular liquidity characteristics of newly-issued, "on-the-run" securities. At the same time, these newly-issued Treasury securities are of particular value to more actively managed private portfolios. Over time, as the Treasury adjusts its issuance pattern, limiting the share of the SOMA’s holdings of newly-issued Treasury securities will make a larger amount of new securities available to satisfy this demand than would otherwise be the case.
Over the coming year, these percentage limits on the size of the SOMA’s participation in the primary market will be: 35 percent for one-year, six-month and three-month bills, 25 percent for the two-year note, 20 percent for the five-year note, and 15 percent for the 10-year note and the 30-year bond.
In the bill sector, the application of the 35 percent limit has already resulted in net redemptions by the SOMA. In the coupon sector, these percentages would have had little impact on the SOMA’s normal bidding to roll maturing securities into recent new coupon issues. However, at lower issuance levels these percentages could imply redemptions of maturing coupons as well.
Secondary market. In managing the SOMA, the FRBNY has relied upon secondary market purchases of Treasury securities as the principal means of achieving the expansion of the asset side of the Federal Reserve’s balance sheet necessary to accommodate the trend growth of Federal Reserve liabilities in the form of currency in circulation. In recent years, the FRBNY has sought to spread its purchases evenly across the entire range of outstanding nominal marketable Treasury coupon securities, while seeking to avoid recently-issued securities, purchasing only those securities that were at least twice "off the run".
The Federal Reserve has attempted to maintain a short average maturity of the SOMA portfolio of Treasury securities. "Maturity liquidity" is thought by the Federal Reserve to be an important portfolio objective to permit a smooth contraction in the size of the SOMA, should it be necessary to adjust to a change in either the size or composition of the System’s balance sheet. However, in the face of both heightened demand for and reduced supply of Treasury bills in 1997 and 1998, the FRBNY refrained from open market purchases of Treasury bills from December 1997 to April 2000, contributing to the lengthening in the SOMA’s average maturity that has occurred in recent years.
Redemptions of the SOMA’s bill holdings, as a consequence of the 35 percent limit in bill auction participation, will tend to further increase the average maturity of the SOMA’s overall holdings, counter to the System’s portfolio objective. These bill redemptions, as well as redemptions of coupon securities which could occur in the future as a consequence of the limits on the SOMA’s primary market participation, will also add to the growth in reserve needs that the Federal Reserve System would need to accommodate.
In order to meet the Federal Reserve’s need to grow the asset side of its balance sheet and consistent with the System’s long-standing preference for maturity liquidity, the FRBNY will focus its purchases more on shorter maturity coupon securities. The FRBNY will no longer seek to spread purchases for the SOMA so that they result in roughly equal percentage holdings of Treasury coupon securities evenly across the maturity spectrum. Rather, in conducting secondary market purchases, the FRBNY will tend to purchase, over time, a greater proportion of off-the-run securities with remaining maturities under two years than it will purchase of off-the-run securities with remaining maturities between 30 years and 10 years. Amounts to be purchased of securities with remaining maturities in the middle of the yield curve will be graduated between the long and the short end.
The same percentage limits to be applied to auction participation will serve as guidelines for the amounts that the SOMA will ultimately be prepared to hold of off-the-run Treasury securities. Thus, the FRBNY will, over time, conduct purchases consistent with the SOMA holding up to:
- 35 percent of Treasury bill issues and of coupon securities with remaining maturities of up to one year;
- 35 to 25 percent graduated between securities with remaining maturities from one to two years;
- 25 to 20 percent graduated between securities with remaining maturities from two to five years;
- 20 to 15 percent graduated between securities with remaining maturities from five to 10 years;
- and 15 percent of securities with remaining maturities from 10 to 30 years.
Given the larger issue sizes of these seasoned, off-the-run securities, these guidelines should provide ample opportunity for purchases for the SOMA over coming quarters.
The timing and amount of all open market operations will continue to be a function of the FRBNY’s assessment of demand and supply conditions in the market for banking system reserves, consistent with the FOMC’s target for the federal funds rate. The mix between temporary and outright operations also will continue to reflect the FRBNY’s assessment of conditions in the market for Treasury securities and SOMA portfolio needs.
The FRBNY will continue to avoid purchasing recently-issued securities in the secondary market.
The FRBNY will continue to purchase Treasury Inflation-Indexed Securities (TIIS) in the secondary market for SOMA, consistent with the FRBNY’s assessment of conditions in the market for TIIS.
Each Thursday afternoon the FRBNY will publish on its website the complete details of the SOMA’s holdings as of the close of business each Wednesday.
The Manager of the SOMA, after consultation with the FOMC, may change the percentage limits noted above as they apply to both primary and secondary market operations. Any such changes or other exceptions will be announced publicly.