Fed's Unintended Role Amid Fiscal Pressures: A New Normal?

The Federal Reserve's increasing intervention in treasury markets highlights a shift beyond its traditional role as a lender of last resort. With fiscal deficits predicted to rise, and U.S. Treasury markets expanding, the Fed's involvement could risk creating asset bubbles and crowding out other investors.

The Federal Reserve appears to be shifting beyond its traditional lender-of-last-resort role, as it responds to burgeoning fiscal pressures amid escalating U.S. deficits. This development poses risks, as the Fed's greater involvement in the market could crowd out other investors and contribute to the formation of asset bubbles.

On September 30, a $2.6 billion drawdown from the Fed's Standing Repo Facility, designed to address cash shortfalls, emphasized the structural issues within the $28 trillion Treasury market. Historically, banks have facilitated treasury market trades, yet recent regulatory changes have impacted their balance sheet capacity to do so profitably.

Experts warn that extending the central bank's reach could lead to unintended consequences, such as moral hazard and market bubbles. As fiscal deficits surge, the necessity for the Fed to redesign financial systems to accommodate liquidity demands will become increasingly pressing.

(With inputs from agencies.)