From Steven Kelly's Without Warning substack, November 27:
The Fed can do better than the Bank of England
While the U.S. financial policymaker complex is focused on structural reforms for improving the functioning of the Treasury market, none will be in place in the short-term (year-end cometh!). With the Treasury market functioning but strained, concern is rising that the Fed may face a situation like the recent, heavily covered government bond (gilt) market blowup in the U.K.
The Bank of England responded to the leverage squeeze in the long-term gilt market by delaying its quantitative tightening (QT) plan to begin selling £80 billion of gilts over the next year. It also got authorization for £100 billion of gilt purchases, but announced just a £65 billion purchase program—and purchased less than £20 billion.
While the gilt market blowup was due to the uniquely material use of “liability-driven investment” (LDI) strategies among U.K. pension funds, a similar market breakage could occur in the U.S.—given low Treasury liquidity, hawkish monetary policy, and high rate volatility, among many other fragilities—without the same specifics.
Indeed, the latest Fed minutes, released this week from their meeting in early November, revealed the following:
A few participants noted the importance of being prepared to address disruptions in U.S. core market functioning in ways that would not affect the stance of monetary policy, especially during episodes of monetary policy tightening. Several participants noted the risks posed by nonbank financial institutions amid the rapid global tightening of monetary policy and the potential for hidden leverage in these institutions to amplify shocks.
As the Fed plans for (and maybe starts communicating in advance of?) such a situation, it should think about mixing open mouth operations with the outlines of an open market operations strategy it hasn’t used since the post-GFC slump: Operation Twist.
Operation Twist
Colloquially dubbed “Operation Twist” (after a similar program instituted in the 1960s for different reasons), the Fed’s “Maturity Extension Program” in 2011-2012 bought $667 billion of long-term Treasuries and sold an equivalent amount of short-term ones. The aim was to balance the desire to provide additional stimulus while nodding to concerns about the size of the balance sheet. Operation Twist sought to put downward pressure on long-term rates—and thus provide additional accommodation—and was expected to have an asymmetrically small impact on short-rates given the Fed’s strong forward guidance about the Fed funds rate....
....MUCH MORE
Here are Steven Kelly's twitter and and academic home:
https://twitter.com/StevenKelly49
https://som.yale.edu/centers/program-on-financial-stability
You are no doubt familiar with the members of the program's advisory board.
Previously from Without Warning:
