The unprecedented speed and scale of the Federal Reserve’s buying of Treasuries and mortgage debt to aid a severely impaired bond market has accomplished that without raising the specter of moral hazard, Federal Reserve Bank of New York researchers wrote in a note.
Pandemic-sparked volatility in March caused liquidity in the world’s biggest bond market to plunge to its worst since the 2008 financial crisis. The Fed responded with purchases of Treasuries and mortgage securities that peaked at more than $100 billion a day combined.
It’s still soaking up about $80 billion of Treasuries and at least $40 billion of mortgage securities a month, and some bond veterans warn that the central bank’s involvement in the market could potentially be encouraging risky behavior, such as excessive borrowing. But a post Thursday in the New York Fed’s Liberty Street blog argued against that.
“The magnitude of the Desk’s purchase program in 2020 ‘to support the smooth functioning’ of the Treasury and agency MBS markets marked those purchases as highly unusual,” wrote Kenneth Garbade, a senior vice president in the New York Fed’s Research and Statistics Group, and Frank Keane, a senior policy advisor.
But they also say that the tool has been used before and “the infrequency of Federal Reserve intervention suggests that relying on the Fed on those rare occasions when markets are in extremis has not materially exacerbated moral hazard.”
Reading over the Fed minutes feels like an episode of the Twilight Zone. This quote in particular is relevant. “many participants judged that yield caps and targets were not warranted in the current environment but should remain an option.”. It doesn’t have to engage in yield curve control because the market is already behaving like it is a fact.Click HERE to subscribe to Fuller Treacy Money Back to top