The Federal Reserve (Fed) has been incredibly active in many different sectors of the fixed-income markets since the pandemic shut down parts of the US economy in early 2020, including restaurants, bars, concerts, sports events, business travel and tourism. Between February 26 and June 10, 2020, the Fed expanded its balance sheet by $3 trillion to $7 trillion. Since June 10, however, the Fed has hit the pause button on the expansion of its balance sheet, taking time to evaluate what has worked well and what has not, and to adjust activities accordingly.
(1) Fed purchases of short-term Treasury Bills of less than one-year maturity, along with repurchase activity, have allowed for the smooth functioning of overnight funding markets critical to the efficiency of the financial system. These overnight markets no longer need any support, and the Fed has stopped purchasing short-term Treasury bills while sharply curtailing repurchase activity.
(2) Purchases at the long-end of the Treasury securities maturity curve of 10 years or longer have been extensive, $280 billion since late February, and have worked to stabilize yields and dampen volatility for securities with maturities of 10 years and longer. The Fed has not committed to a yield curve control program, however, the Fed has clearly wanted to and succeeded in dampening price volatility in the Treasury securities markets.
(3) The Fed’s activity in US Treasury securities has dramatically changed sentiment. Using CME’s daily updated Market Sentiment Meter, we observe that back in March 2020 as the pandemic forced shutdowns around the world, the 10-year Treasury market was in an “Anxious” state. Now, with the Fed activity calming markets, the sentiment state has moved away from “Anxious,” gone through “Balanced,” which implies typical risk levels for that market, and has become “Complacent” – a sign that market participants believe the Fed has their backs.
For a more complete understanding of the Market Sentiment Meter, please visit our web site for daily updates, explanations, and in-depth related research at https://www.cmegroup.com/tools-information/market-sentiment-meter.html.
(4) The Fed’s largest purchases have been in intermediate Treasury maturities, ranging from one year to less than 10 years, totaling almost $1.3 trillion since late February and still climbing even as other asset purchase programs have been curtailed. These purchases may have been made with the intention of relieving some pressure from the massive auctions of new debt by the US Treasury, and in that regard this is a fusion of fiscal and monetary policy. Indeed, it is not at all clear that the large purchases of these intermediate maturity Treasury notes made much, if any, difference to the shape of the yield curve given the effectiveness of the Fed’s other activities to anchor the federal funds rate at zero, and to dampen volatility and stabilize yields on the long-end of the maturity curve. [ Please see our research on Modern Monetary Theory ]
(5) The effects of the announcement of the Fed’s entry into municipal bonds and corporate credit were more important than the actual purchases and dramatically impacted the price discovery process. These programs were delayed in terms of implementation and the purchases have been small. The market impact, however, was substantial and occurred at the time of the announcement, not at the time when the purchases were made.
(6) The Fed has sharply curtailed swap lines to central banks. The currency markets are functioning smoothly and there is little demand for currency swap lines with the Fed from central banks around the world.
(7) The Fed also has reduced support to primary dealers in the bond markets. There is ample evidence of excellent liquidity in these markets and primary dealers do not need the loans.
While the Fed may curtail its asset purchases in total and adjust the mix of securities within its portfolio, the federal funds futures market continues to show expectations for zero rates two years out or more. And, there is significant growth in the trading volume and open interest for call-options-based Eurodollar deposit rate futures with strike prices implying zero or negative rates, suggesting that market participants expect the Fed to maintain short-term rates at near zero well into the future.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Bluford “Blu” Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. With more than 35 years of experience in the financial services industry and concentrations in central banking, investment research, and portfolio management, Blu serves as CME Group’s spokesperson on global economic conditions.
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