Bloomberg News reports that the Federal Reserve unwind of the balance sheet is at its maximum capacity, although the duration for which it would go on is not certain. It largely depends on whether the bond markets globally can continue functioning without an incident.
Strategists at Goldman Sachs state that any kind of volatility shock might lead to a further decline of liquidity in the market, which is something that central banks across the globe are not likely to tolerate. As far as the supply of liquidity is concerned, it has not been strong enough but poor, and these strategists also note that with the top-of-the-book depth in the market, many places are closing to the worst levels in the five years.
The bond markets have already manifested lines of massive dislocations. This is because the US Treasuries has experienced a kind of biggest swing since the beginning of the coronavirus pandemic, whereas the gilts market has witnessed the wildest move to date. Recently, the ructions compelled the Bank of England to buy bonds and seek other measures to ensure that the market continues functioning. This has triggered concerns that, eventually, the Fed will have to prop up the almost $24 trillion Treasury market.
Bloomberg News reports that now that the central bank is not the biggest buyer of Treasuries, it is still unclear which entity will replace the Fed as the buyer of the last resort. As much as $29 billion in Treasury was purged by the foreign monetary officials in the week that ended October 5th, thereby bringing the decline of four wee in the holdings to about $81 billion. As per data from the Federal Reserve. This is perhaps the most extreme outflow since March 2020, leaving the holdings at a total of $2.91 trillion. Simultaneously, the larger commercial banks in the United States are shrinking already as far as their securities portfolio is concerned, in contrast to what it was last year while they were still buying.
The policymakers believe that the markets will be effectively operational, citing a myriad of tools of the Fed that might serve as a backstop for liquidity during times of financial despair, such as swap lines of central bank liquidity and the domestic as well as foreign repurchase agreement facilities.
Despite the same, strategists at Goldman have stated that while the repo of the Fed will be providing alternative means of the intermediation of the market and raising liquidity, they are not just appropriate substitutes for the capacity of risk transfer.
