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The Federal Reserve's Portfolio and its Effect on Interest Rates

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Abstract

We explore the historical composition of the Federal Reserve's Treasury portfolio and its effect on Treasury yields. Using data from 1985 to 2016, we show that the divergence of the composition of the Federal Reserve's portfolio from overall Treasury securities outstanding is associated with a statistically significant effect on interest rates. In aggregate, when the Federal Reserve's portfolio has shorter maturity than overall Treasury debt outstanding, measures of the term premium are higher at all horizons; likewise, when the Federal Reserve's portfolio has longer maturity, term premiums are lower. In addition, at the individual security level, differences in Federal Reserve holdings from overall Treasury debt outstanding are correlated with measures of pricing errors and liquidity premiums. We discuss the mechanism for this effect, which could include elements of preferred-habitat theory as well as the fiscal theory of the price level.

Suggested Citation

  • Jeff W. Huther & Jane E. Ihrig & Elizabeth C. Klee, 2017. "The Federal Reserve's Portfolio and its Effect on Interest Rates," Finance and Economics Discussion Series 2017-075, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2017-75
    DOI: 10.17016/FEDS.2017.075
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    More about this item

    Keywords

    Federal Reserve; SOMA portfolio; Treasury securities; Portfolio composition;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • N12 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - U.S.; Canada: 1913-
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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