QUESTION: The Treasury department is issuing trillions of dollars in new debt to finance all these COVID-19 relief bills. The virus is crushing economies all over the world and everyone is hoarding cash. So, who’s buying our debt?
ANSWER: The short answer: the Federal Reserve, our nation’s central bank. However, this response masks an important nuance.
The economic outlook here and abroad is uncertain and very risky. As a consequence, investors are demanding liquidity – shorter-term debt instruments with less inflation and repayment risk. Plus, investors like to diversify their portfolios. They do not want to invest all their savings in one particular asset (e.g., U.S. Treasury debt).
In response, the Treasury department and the Federal Reserve are working in concert to create a market for the federal government’s massive new COVID-related debt. For its part, the Treasury department has responded to investor liquidity preferences by issuing mostly short-term debt. Most investors already hold Treasury securities in their portfolios, however, and adding more would upset their portfolio balance. The Federal Reserve has responded by temporarily purchasing older-issue, longer-term debt from investors in the secondary market. The Fed’s actions solve two problems: it provides investors with the cash they need to purchase the new Treasury debt, and it helps investors maintain a diversified portfolio.
Topline? The Federal Reserve’s holdings of U.S. Treasury debt have increased markedly - this is unambiguously true - but the Fed has been very transparent about its actions, including the temporary nature of this strategy. Indeed, Fed purchases of U.S. Treasuries have already slowed markedly as its focus shifts to supporting several newly created business lending facilities. For the time being, the Fed’s strategy has been rewarded with low inflation and low interest rates.
It is important to point out, however, that this is not “normal” Federal Reserve behavior. Our extraordinary climate - a deadly global pandemic combined with economic devastation - has forced the Fed to exercise extraordinary emergency measures. There is an expectation that when this crisis is over, the Federal Reserve will take action to reverse course, disgorge the Treasury securities it holds, and resume more conventional monetary policy behavior.