Fed leans towards shortening maturity of Treasury holdings

Bloomberg

Federal Reserve policy makers look to be leaning towards shortening the average maturity of their holdings of Treasury securities once they complete normalization of the balance sheet later this year.
Fed Vice Chairman for Supervision Randal Quarles and Cleveland Federal Reserve Bank President Loretta Mester both said this week they would favor such a move, while also noting that no final decision has been made. “My initial inclination is to think that we should go, all things considered, we should go back to a shorter duration,” Quarles said at a monetary policy forum in New York.
The Fed’s decision on what securities to hold on its balance sheet is of critical importance to investors. A shift in the central bank’s portfolio away from longer-dated Treasury bonds towards bills would tend to put downward pressure on short-term interest rates — unless the Treasury Department elected to issue more bills in response.
A shorter-dated portfolio would give the Fed added firepower if a cut in interest rates to zero was not enough to counter a downturn in the economy. In that event, it could sell its short-term Treasuries or allow them to run off and use the proceeds to purchase longer-term debt, in an operation known as Operation Twist. That would put downward pressure on Treasury bond yields, providing support to the economy by lowering borrowing costs for home buyers and corporations issuing debt.

$3.98 TRILLION
The duration of the Fed’s portfolio lengthened during the financial crisis as it added to its holdings of longer-term debt via quantitative easing. In a January 18 note, Deutsche Bank analysts Steven Zeng and Matthew Luzzetti wrote that the Fed’s Treasury holdings “are estimated to have an average maturity of 7.7 years, or 1.9 years longer than the outstanding Treasury market and 2.3 years longer compared to private sector holdings.”
In an effort to normalize its balance sheet, the Fed is currently reducing its bond holdings by a maximum of $50 billion per month by opting not to reinvest some of the proceeds of securities as they mature. The balance sheet now stands at $3.98 trillion, down from a record high of $4.52 trillion in January 2015.
Minutes of the Fed’s January meeting released this week showed widespread agreement on ending that runoff this year. Left unanswered though is what investment strategy the central bank will adopt after that.
“The question of the ultimate composition of our balance sheet in the longer run is a very important one,” Fed Chairman Jerome Powell told reporters on Jan. 30. “It’s one that we see ourselves as coming to, you know, fairly soon, as in, in coming meetings.”