Fed May Become Biggest Buyer of U.S. Treasuries Again as Purchases Resumed

Aug. 16 (Bloomberg) -- Andrew Popper, chief investment officer at SG Hambros Bank Ltd., discusses China's currency reserves and his asset allocation strategy. He talks with Francine Lacqua on Bloomberg Television's "Start Up." (Source: Bloomberg)

The Federal Reserve will likely reemerge as the biggest buyer of Treasuries when it resumes purchasing U.S. government securities today to prevent money from draining out of the financial system.

JPMorgan Chase & Co. strategists estimate the Fed will buy about $284 billion in Treasuries over the next year, or more than the combined purchases of Japan and China during the year ended May. Analysts at Credit Suisse Group AG forecast purchases of $307 billion, with $47 billion coming from the proceeds of maturing agency debentures.

The central bank will acquire Treasury notes due from 2014 to 2016 today and debt due in 2016 to 2020 on Aug. 19 with the proceeds from its maturing mortgage holdings. The Fed was the biggest buyer in the Treasury market between March and October 2009 as it purchased $300 billion in Treasuries to help keep borrowing costs low and bolster the housing market.

“The Fed’s actions have shifted yields into a new paradigm,” said George Goncalves, head of interest-rate strategy at Nomura Holdings Inc., one of 18 primary dealers that trade directly with the central bank. “The Fed will attempt to keep the range tight going forward as it strangleholds rates and its purchases should cap any major sell-off in Treasuries. The yield on the 10-year should hold in our forecast range of 2.5 to 3.5 percent.”

Yields on benchmark 10-year note yields fell 11 basis points to 2.56 percent yesterday in New York, according to BGCantor Market Data. That’s the least since March 2009, generic data compiled by Bloomberg show.

Concentrated Purchases

The Fed will seek to keep its holdings in the System Open Market Account, or SOMA, at about $2.054 trillion, the amount the central bank held on Aug. 4, the Fed announced last week. The central bank plans to “concentrate its purchases” in 2- to 10-year Treasuries, the New York Fed said Aug. 10. The action was the Fed’s first attempt to bolster the economy in more than a year. The reinvestment policy applies to agency debt and agency mortgage-backed securities held by the central bank.

“By maintaining the SOMA portfolio at the same level, the Fed will stem the gradual ‘quantitative tightening’ that would otherwise occur, while also furthering its goal of moving toward a Treasury-only portfolio,” JPMorgan strategists Srini Ramaswamy and Kimberly Harano wrote in a report Aug. 13. “On the face of it, this change seems minor, and almost operational in nature. However, it is not insignificant.”

The Fed last week announced a total of 9 outright purchase operations, including one for Treasury Inflation Protected Securities, for the month ended Sept. 13, for an estimated $18 billion in total. The Fed will report its purchase schedule in one month increments, with amounts based on the principal payments from the Fed’s agency debt and agency mortgage-backed securities.

‘A Bit Faster’

The central bank’s purchases should average about $2 billion per operation, according to Wrightson ICAP, a Jersey City, New Jersey-based research unit of ICAP Plc specializing in U.S. government finance.

“We expect the program to be successful in lowering term rates a bit faster than they were already going to fall,” wrote Carl Lantz and Ira Jersey at Credit Suisse in a note published on Aug. 12. “The economic impact of the program is likely to be far less than prior Fed operations that involved the monetization of private assets.”

The central bank last week left the overnight interbank lending rate target unchanged in a range of zero to 0.25 percent, where it’s been since December 2008.

Last year’s Treasury purchases were the first outright of U.S. government debt by the Fed since the 1960s. The central bank completed purchases of $1.45 trillion in mortgage-backed and housing agency debt in March 2010.