Three months after the Federal Reserve stopped reinvesting all of the maturing Treasury securities in its portfolio -- allowing $30 billion a month to run off -- its holdings of the debt ought to be lower by $90 billion.
Soaring inflation is slowing that decline. That’s because the Fed’s Treasury holdings include inflation-protected securities, and the total value incorporates adjustments to their principal determined by changes in the consumer price index -- which have been hefty over the past year.
In short, the $30 billion a month of Treasuries that the Fed isn’t replacing is being partially offset by the increasing face value of its inflation-protected holdings.
The Fed’s System Open Market Account held $5.77 trillion of Treasuries on June 1, when the balance-sheet reduction plan kicked off. After the end of August, it held roughly $5.69 trillion, a difference of $78 billion when taking rounding into account. The difference between that amount and $90 billion mostly reflects the increase in inflation compensation on TIPS.
“The pace of decline is going as intended after adjusting for TIPS inflation compensation,” Morgan Stanley strategist Guneet Dhingra said in a Sept. 7 report.
The Fed bought about $3 trillion of Treasuries from March 2020 to March 2022 in a bid to boost market liquidity after the onset of the pandemic, and to support the economy while keeping its policy rate at 0%. Now as part of a move to tighten policy it’s shrinking the portfolio by letting securities mature. Former Treasury Secretary Lawrence Summers is among those who’ve said the massive balance-sheet expansion contributed to the inflation crisis.
The New York Fed noted the impact from inflation compensation on the size of the securities portfolio in a blog post Thursday.
“In recent months, increases in the Consumer Price Index have resulted in an adjustment higher in the inflation compensation associated with SOMA TIPS holdings, offsetting some of the reduction in the par value of Treasury securities holdings associated with runoff,” the article said.
Starting this month, under a plan announced in May, the Fed’s runoff cap for Treasuries increases to $60 billion a month. A separate monthly runoff cap for agency and mortgage-backed debt doubles to $35 billion.
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