How does the Fed purchase bonds

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S_Track
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How does the Fed purchase bonds

Post by S_Track » Fri Jul 20, 2018 8:24 pm

I was reading a post on Investopedia about the tools available to Fed to manipulate the economy. I was confused by the statement below when they talk about the Fed purchasing bonds. Although it makes sense this would expand the money supply in the economy but how do they physically do that? Can bond holders sell back to the government?

"If the Fed buys bonds in the open market, it increases the money supply in the economy by swapping out bonds in exchange for cash to the general public."

https://www.investopedia.com/articles/e ... ession.asp

Gill
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Re: How does the Fed purchase bonds

Post by Gill » Fri Jul 20, 2018 8:28 pm

Simply by buying in the open market just like any other buyer. The money paid for the bonds increases the money supply.
Gill

alex_686
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Re: How does the Fed purchase bonds

Post by alex_686 » Fri Jul 20, 2018 8:30 pm

The Treasury Department, which is part of the government, issues bonds
.
The Fed, which is kind of independent of the government, buys the bonds. They physically buy bonds the same you do. They phone up on of their brokers and buy the bonds. Technically they use a Bloomberg terminal like other institutional players but the idea is the same.

Ben Mathew
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Re: How does the Fed purchase bonds

Post by Ben Mathew » Fri Jul 20, 2018 8:34 pm

S_Track wrote:
Fri Jul 20, 2018 8:24 pm
Can bond holders sell back to the government?
Yes, why not? If the Fed is buying, you can sell to them just as you can sell to anybody else.

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Oicuryy
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Re: How does the Fed purchase bonds

Post by Oicuryy » Fri Jul 20, 2018 9:12 pm

This write-up from the New York Fed is a little dated. But the mechanics of their bond trading haven't changed much.

Open Market Operations

Ron
Money is fungible | Abbreviations and Acronyms

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SteelyEyed
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Re: How does the Fed purchase bonds

Post by SteelyEyed » Fri Jul 20, 2018 9:49 pm

They have a TreasuryDirect account. You better hope that they don't forget the password!

OnTrack
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Re: How does the Fed purchase bonds

Post by OnTrack » Fri Jul 20, 2018 10:02 pm

Oicuryy wrote:
Fri Jul 20, 2018 9:12 pm
This write-up from the New York Fed is a little dated. But the mechanics of their bond trading haven't changed much.

Open Market Operations

Ron
I like this write up better, see pages 6 - 8 for open market operations.
https://ia800307.us.archive.org/10/item ... ederal.pdf

JBTX
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Re: How does the Fed purchase bonds

Post by JBTX » Sat Jul 21, 2018 12:34 am

It is worth noting that the recent "quantitative easing" wasnt the same thing as open market operations. In simplistic (and possibly not entirely correct) terms QE was fed buying bonds from banks, with the result of banks having larger reserves. Unlike OMO, the money didn't flow back into the economy directly. The impact was more indirect. The main impact of fed buying bonds was to increase the price of bonds and decrease long term bond rates. The impact was thus far more muted (but far less risky). Those calling QE "printing money" weren't really correct, both literally and figuratively.

https://www.cnbc.com/id/100760150

Choy
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Re: How does the Fed purchase bonds

Post by Choy » Sat Jul 21, 2018 2:10 am

alex_686 wrote:
Fri Jul 20, 2018 8:30 pm
They phone up on of their brokers and buy the bonds. Technically they use a Bloomberg terminal like other institutional players but the idea is the same.
Actually, they put out requests with criteria for securities they want to purchase and let primary dealers directly bid on how much they want to sell the securities to the Fed for. They don't use a Bloomberg terminal for this, they use a special system called FedTrade (the link posted above to the FRBNY site describes it).

Only primary dealers (aka the big banks) can participate in these auctions.

Also, the Fed does not purchase treasuries directly from the Treasury. They can only buy them on the open market.

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#Cruncher
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Re: How does the Fed purchase bonds

Post by #Cruncher » Sat Jul 21, 2018 7:13 am

Choy wrote:
Sat Jul 21, 2018 2:10 am
Also, the Fed does not purchase treasuries directly from the Treasury. They can only buy them on the open market.
Isn't buying at an auction considered to be purchasing "directly from the Treasury"? I often see purchases by SOMA (System Open Market Account according to the Open Market Operations link provided by Oicuryy above) for TIPS auctions. E.g., $706 million at last Thursday's 10-year auction.

Choy
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Re: How does the Fed purchase bonds

Post by Choy » Sat Jul 21, 2018 10:13 am

#Cruncher wrote:
Sat Jul 21, 2018 7:13 am
Choy wrote:
Sat Jul 21, 2018 2:10 am
Also, the Fed does not purchase treasuries directly from the Treasury. They can only buy them on the open market.
Isn't buying at an auction considered to be purchasing "directly from the Treasury"? I often see purchases by SOMA (System Open Market Account according to the Open Market Operations link provided by Oicuryy above) for TIPS auctions. E.g., $706 million at last Thursday's 10-year auction.
Short answer: Traditionally the Fed purchases Treasuries including TIPS on the secondary market. However the principal from the large purchases used to stimulate the economy are reinvested directly into newly issued Treasuries as they mature.

https://www.newyorkfed.org/markets/opol ... icy_170920

https://www.federalreserve.gov/faqs/how ... rnment.htm

Long answer: Treasury auctions are actually conducted by the Federal Reserve Bank of New York. Even if you participate through TreasuryDirect, the auction is ultimately run by the Fed. The Fed auctions off new debt issued by the Treasury and purchases it back from primary dealers in a separate auction if they want to increase the holdings of the SOMA portfolio. If they simply bought directly from the Treasury and held it in their account, they wouldn’t be introducing cash into the economy.

For the purposes of reinvesting principal from their currently held securities, the Fed is essentially buying (on the Fed’s behalf) and selling (on the Treasury’s behalf) at the same time. But this is only to maintain the status quo until they fully unwind their holdings. They unwind their holdings by simply not reinvesting everything as the securities mature.

https://www.newyorkfed.org/aboutthefed/ ... fed41.html
Last edited by Choy on Sat Jul 21, 2018 10:19 am, edited 1 time in total.

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Oicuryy
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Re: How does the Fed purchase bonds

Post by Oicuryy » Sat Jul 21, 2018 10:18 am

JBTX wrote:
Sat Jul 21, 2018 12:34 am
It is worth noting that the recent "quantitative easing" wasnt the same thing as open market operations.
Yes it was. The Fed conducts two types of open market operations, temporary and permanent. QE purchases were permanent open market operations.

See this statement from the FRBNY trading desk. It describes the procedures for the QE2 purchases. Note that is says, "Purchases will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions operated through the Desk’s FedTrade system." That is normal procedure for permanent open market operations.
https://www.newyorkfed.org/markets/opol ... 01103.html

#Cruncher wrote:
Sat Jul 21, 2018 7:13 am
Isn't buying at an auction considered to be purchasing "directly from the Treasury"?
The Fed can choose to roll over maturing Treasuries at auction. Trading maturing Treasuries for new ones is not considered "purchasing directly" since it does not involve creating new money.

Ron
Money is fungible | Abbreviations and Acronyms

JBTX
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Re: How does the Fed purchase bonds

Post by JBTX » Sat Jul 21, 2018 11:34 am

Oicuryy wrote:
Sat Jul 21, 2018 10:18 am
JBTX wrote:
Sat Jul 21, 2018 12:34 am
It is worth noting that the recent "quantitative easing" wasnt the same thing as open market operations.
Yes it was. The Fed conducts two types of open market operations, temporary and permanent. QE purchases were permanent open market operations.

See this statement from the FRBNY trading desk. It describes the procedures for the QE2 purchases. Note that is says, "Purchases will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions operated through the Desk’s FedTrade system." That is normal procedure for permanent open market operations.
https://www.newyorkfed.org/markets/opol ... 01103.html

#Cruncher wrote:
Sat Jul 21, 2018 7:13 am
Isn't buying at an auction considered to be purchasing "directly from the Treasury"?
The Fed can choose to roll over maturing Treasuries at auction. Trading maturing Treasuries for new ones is not considered "purchasing directly" since it does not involve creating new money.

Ron
I won't pretend to be an expert, but I recall reading a couple of interesting articles explaining how QE was misunderstood by many people. my recollection:
- for one QE was more targeted at long term treasuries and MBS vs shorter duration treasuries typical of OMO.
- It increased bank reserves held at the fed, which by their explanation didn't really create more money to be lent out, etc. It just sat there as reserves

There was an interesting article by Fitch years ago that kind of blew my mind. It explained how most people get QE wrong, in great detail. I wish I could find it.

Perhaps it is considered part of "open market operations", but would be better stated as not "traditional open market operations". If I can ever find the explanation I will post it.

edit: Here is the QE paper I referenced. It says nothing about whether QE is OMO or not, so I may have gotten that wrong. it does appear QE has significant differences than your traditional OMO concentrating on shorter term securities.

https://www.kreditopferhilfe.net/docs/S ... _14_13.pdf

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