In remarks at the Annual Primary Dealer Meeting, Roberto Perli, manager of the NY Fed’s System Open Market Account (SOMA) provided an update on balance sheet reduction, stating that usage of the ON RRP has been very responsive to market rates.
The over $1.7 trillion decline in ON RRP balances since the debt limit suspension last June is entirely consistent with how that facility was designed. As alternative private instruments started offering slightly higher rates, money market funds, which are by far the largest users of the ON RRP, responded by reallocating their investments away from ON RRP and toward those alternative investments.
The ON RRP has absorbed virtually the entirety of balance sheet runoff, on net, which is primarily why reserves have not declined since the runoff process started.
One of the indicators Perli highlighted is the share of Treasury repo trades conducted at or above the IORB rate. When repo counterparties trade at rates above the IORB rate, they are willing to pay a premium to attract cash from banks that would otherwise earn IORB on their balances. That could be indicative of a more urgent demand for liquidity. As with the other indicators, this metric today also tells a fairly sanguine story.
He also noted that while the past two years of balance sheet runoff have proceeded smoothly, central bankers cannot take this performance for granted and must continue to manage risks and carefully monitor money market conditions.
Slowing the pace of runoff is one effective way to manage those risks. Doing so allows money markets and the banking system to adapt to progressively lower levels of reserves. It also provides more time to collect data and assess the level and evolution of reserve demand. That careful and gradual approach is consistent with the plans laid out by the Federal Open Market Committee (FOMC) prior to the start of the balance sheet reduction program. In that sense, the FOMC’s recent announcement to slow quantitative tightening is simply the execution of that existing plan.
“I can confidently say that the ON RRP has supported the efficient implementation and transmission of monetary policy so far. Overall, our monetary policy implementation framework has performed extremely well, and I expect it will continue to do so in the future,” he said. “Taken together, the indicators and tools at our disposal constitute a powerful set of instruments, and they support my confidence that the balance sheet reduction process can continue smoothly.”