On 10 December, the US Federal Reserve surprised everyone by announcing that it would resume expanding its balance sheet on 12 December, just days after it had stopped reducing it.
Although it came earlier and was more substantial than expected, the expansion of the Fed's balance sheet should not be viewed as a new phase of quantitative easing, or QE. The Fed initiated such programmes during the 2008 financial crisis and again in response to the COVID-19 pandemic in March 2020. On both occasions, it expanded its balance sheet by purchasing large quantities of long-term government securities, thereby injecting a large amount of central bank money into the financial system. These QE initiatives helped ease financial pressures and bolstered economic activity by lowering bond yields. However, no comparable situation is occurring today. The Fed will inject liquidity once more, but its purchases will focus on short-term securities and, above all, they are not expected to increase the size of its balance sheet as a proportion of GDP, unlike past QE experiences.
The decisions taken on 10 December bear a closer resemblance to those taken in the aftermath of the securities repurchase market crisis in September 2019. At that time, the Fed greatly underestimated the impact of new liquidity rules on the central bank money requirements of banks. It had waited far too long to halt its balance sheet reduction programme, or QT, which had depleted the reserves that banks held in excess of their needs, preventing them from meeting cash demands at a critical moment. Consequently, short-term market rates skyrocketed, forcing the Fed to act swiftly.
The tensions observed in the money markets in recent months, which were certainly less intense than at the end of QT1, have remained persistent enough to persuade the Fed that the existing stock of central bank money is insufficient for the effective implementation of its monetary policy. To remedy this, the Fed is removing the aggregate limit on these securities repurchase agreements and reinstating its outright purchases of T-bills. The specifics regarding the pace of these purchases will be determined as they progress, but it is evident that they will be maintained at a relatively steady rate at least until next April to mitigate the risk that the annual account closures in December and the tax payments in April will intensify liquidity pressures. Furthermore, the Fed will adjust its purchases to ensure that the supply of central bank money remains at a level it considers sufficiently “ample,” likely exceeding 10% of GDP. Besides their impact on the money markets, these purchases will position the Fed as one of the primary net purchasers of T-bills in 2026 and will contribute to the steepening of the yield curve.
However, the Fed will be compelled to continuously monitor bank balance sheets and money markets, as mandated by the regulatory framework. However, quantifying the central bank money requirements of banks poses significant challenges. Successive crises and QE, the decline in the value of collateral, and the expectations of banking regulators since the run on deposits in March 2023 have increased those requirements. The ongoing expansion of the securities repurchase markets, which coincides with the expansion of the US public deficit, along with innovations in the payments sector, are likely to increase them further. The challenge will lie in accurately assessing the extent of this increase.
