Tags: Money | Federal Reserve | Treasury bonds

How Does the Fed Affect Treasury Bonds?

By    |   Friday, 10 July 2015 03:11 PM

The Federal Reserve monitors the economy and analyzes such issues as inflation expectations before taking action. It will buy and hold Treasury bonds, which are matched by the reserve balances held by the banking system, with the aim of stimulating the economy. This method was increased significantly following the 2008 economic meltdown.

According to the Federal Reserve’s Board of Governors, “an increase in reserve balances in the banking system would push down current and expected future levels of short-term interest rates; such an action would serve to boost the economy and variables like bank lending and the money supply.” The Fed had hoped to bring its Treasury securities back to normal over time. Holding onto high levels of reserve balances and low short-term interest rates could increase inflation expectations.

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When the Fed failed to stimulate the economy by cutting interest rates during the economic crisis, it increased its purchase of Treasury bonds to lower interest rates and bond yields, Sy Harding wrote in Forbes. This would promote borrowing and spending within the private sector for continued economic growth, but it resulted in moderate signs of an economic recovery that required additional buying of bonds, Harding wrote.

The measures taken by the Fed affect the way bond traders buy or sell bonds. For example, the anticipation of when the Fed begins selling bonds could lead to a sell-off by bond holders, affecting yields.

The interest the Fed earns on bonds is used for operating costs with the remainder going to the Treasury Department, which handles government debt. The Fed earned $115.9 billion in interest income from bonds in 2014, according to Michael S. Derby in The Wall Street Journal.

Along with income from other sources, the Federal Reserve sent a record $98.7 billion in profits to the Treasury, mainly from the high interest earnings through its bond holdings.

Future moves by the Fed regarding bond holdings rely on an uncertain economy. The Federal Reserve might raise short-term interest rates and pay higher interest on its reserves. To get back to the normal levels before the economic crisis, the Fed’s holdings of bonds could shrink, reducing its interest income. This could result in different strategies ahead and affect the buying or selling of Treasury bonds.

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The Federal Reserve monitors the economy and analyzes such issues as inflation expectations before taking action. It will buy and hold Treasury bonds, which are matched by the reserve balances held by the banking system, with the aim of stimulating the economy.
Federal Reserve, Treasury bonds
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2015-11-10
Friday, 10 July 2015 03:11 PM
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