(Bloomberg) — The manager of the Federal Reserve’s massive portfolio of securities said the central bank’s effort to reduce the size of its balance sheet is beginning to place pressure on the market for repurchase agreements.

That pressure likely means the Fed’s tools for controlling short-term interest rates will become increasingly important, Roberto Perli, manager of System Open Market Account at the New York Fed, said in prepared remarks Thursday.

As the size of the Fed’s balance sheet continues to decline and bank reserves shift to ample from abundant levels, upward pressure on money market rates will likely increase, Perli said at an event hosted by the New York Fed and Columbia University’s School of International and Public Affairs (SIPA). 

The move in money market rates “represents a normalization of liquidity conditions and is not a cause for concern,” he said. “However, it does imply that, in the future the SRF is likely to be more important for rate control than it has been in the recent past,” he added, referring to the Fed’s Standing Repo Facility. 

The Fed has been shrinking its holdings of debt since June 2022. Last month policymakers slowed the pace of the runoff by reducing the cap on the amount of Treasuries allowed to mature each month without being reinvested to $5 billion from $25 billion. The cap on mortgage-backed securities was left unchanged at $35 billion. 

Fed officials and investors are keeping a keen eye on the amount of cash that banks park at the central bank to determine when it should halt its balance-sheet unwind, a process known as quantitative tightening or QT. If the amount of money on hand goes up, it suggests there’s more liquidity in the system, allowing the Fed to continue QT for longer.

The Fed’s balances totaled $3.24 trillion in the week through May 14, up from $3 trillion the prior week, according to the latest Fed data. That’s just below the level where the central bank started QT almost three years ago. Wall Street strategists estimate that in order to maintain ample liquidity — and avert stress — the Fed needs to keep balances above $3 trillion to $3.25 trillion.

Perli acknowledged that the SRF —  which allows eligible banks and primary dealers to borrow funds overnight in exchange for Treasury and agency debt at a rate set by the Fed — can help reduce the amount of reserves a central bank must supply to “operate efficiently in an ample reserves regime.”

“The more frictionless the facility is, the more effective it will be, and the lower the reserve buffer needed to account for the uncertainty that is inherent in monetary policy implementation,” Perli said. 

Perli said earlier this month the New York Fed plans to make early-settlement operations for the SRF part of the regular schedule in a bid to support smooth market functioning. The institution had started offering additional daily repo operations even before last month’s bond-market swings. The extra operations were offered at the end of December and end of March, periods when rates on repurchase agreements tend to spike as banks pare their activity in order to shore up balance sheets for regulatory purposes. 

Perli noted that while the SRF is an “important facility,” there are issues that deter counterparties from using it. Officials are looking for ways to address these headwinds, he said. These include the inability for dealers to net these transactions off their balance sheets, and the uncertainty of award allocations. 

“These frictions add to the costs that counterparties face when using the facility and mean that counterparties generally require private market repo rates to trade materially above the SRF minimum bid rate before using the facility,” he said, noting that these frictions were apparent in December 2024. 

–With assistance from Maria Eloisa Capurro.

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