Some very astute readers raised interesting questions about the implied rundown rate in the Fed’s SOMA portfolio, as presented in our recent commentary “The Fed’s Dilemma.” Specifically, the chart in that commentary presented the distribution of the SOMA account’s holdings of securities by maturity class and assumed that the run-off in the Fed’s portfolio, should the Fed stop reinvesting the proceeds of maturing issues, would occur accordingly. The readers noted that in the case of the SOMA account agency-backed MBS, for example, that principal and early repayments routinely occurred and would reduce substantially the duration and run down of those assets relative to their nominal maturities. The issue then becomes one of attempting to refine the projections as to how fast the SOMA portfolio might return to a more normal position, considering alternative interest-rate scenarios, growth of the economy, and increases in currency outstanding.
Nicely Transparent
Digging into the NY Fed’s website revealed an interesting set of annual reports summarizing in detail the SOMA account operations (which is a testament to how transparent the Fed has actually become with regard to its operations, though one has to work some to find the information). The most recent report is entitled “Domestic Open Market Operations 2014.” That report presents summary information on many aspects of the SOMA portfolio, including charts on monthly estimates of portfolio duration, distribution of principal payment flows, etc., along with simulations of alternative interest-rate scenarios and how they might affect the size of the portfolio, assuming that the FOMC follows the plan outlined in its revised “Policy Normalization Principles and Plans.” But also buried in the website is a spreadsheet, that includes the data behind the charts contained in the report. The details are interesting and allow one to trace, for example, the trend in the duration of the various types of assets in the SOMA portfolio over time. At yearend 2014, the duration of the overall portfolio was 5.8 years, whereas the duration of the portfolio’s Treasury holdings was 7.3 years, compared with 5.8 years for MBS.
The data also allows us to refine estimates of what might happen when the FOMC decides to stop reinvesting the proceeds from maturing Treasuries and MBS. In fact, the spreadsheet contains simulations of the payback patterns under alternative assumptions for MBS. Without reproducing that data here, the bottom line is this: the time it will take for 50% of the portfolio, both MBS and Treasuries, to run off and for the SOMA portfolio to come roughly into line with the increase in outstanding currency is shortened considerably and is estimated to occur sometime in late 2020. While the basic conclusions of the previous commentary hold with respect to operational burdens the portfolio pose for short run interest rate policies, it does appear that that the transition of the portfolio to a more normal balance will take considerably less time than is implied by simply looking at the maturity structure of the assets in the portfolio.
Bob Eisenbeis, Vice Chairman & Chief Monetary Economist.