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

55 Pages Posted: 17 Jul 2017

See all articles by Jeffrey Huther

Jeffrey Huther

Board of Governors of the Federal Reserve System

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions

Elizabeth Klee

Board of Governors of the Federal Reserve System

Date Written: 2017-07

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.

Keywords: Federal Reserve, SOMA portfolio, Treasury securities, Portfolio composition

JEL Classification: E42, E52, N12, O23

Suggested Citation

Huther, Jeffrey and Ihrig, Jane E. and Klee, Elizabeth, The Federal Reserve's Portfolio and its Effect on Interest Rates (2017-07). FEDS Working Paper No. 2017-075. Available at SSRN: https://ssrn.com/abstract=3003049 or http://dx.doi.org/10.17016/FEDS.2017.075

Jeffrey Huther (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-3372 (Phone)
202-736-5638 (Fax)

Elizabeth Klee

Board of Governors of the Federal Reserve System ( email )

20th and Constitution Ave NW
Washington, DC 20551
United States

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