Open Market Operations

The central bank of a country employs open market operations to implement the monetary policy. In the US, this is done by Federal Reserve. Open market operations involve buying and selling government securities in the market to control the money supply and maintain the short-term interest rates. They are allowed to buy and sell only from a limited basket of securities. This is done by the trading desk at the Federal Reserve Bank of New York. These open market operations (OMOs) have short-term and long-term objectives.

The short-term objectives are specified by the Federal Open Market Committee or FOMC.

Open market operations are either temporary or permanent.

The Federal Reserve has a System Open Market Account or SOMA through which it outrightly buys securities for its portfolio. This is a permanent OMO. When the circulation of currency is greater, the FED steps in to mop up funds and reduce long-term interests. They help currently in reinvesting the principal payments from the Fed’s holdings as per the FOMC policies.

Types of Securities

Treasury Securities

The Fed’s Trading Desk buys treasury securities to keep the treasury market stable. They also roll over maturing Treasury holdings in auctions. Post-2008, the Trading desk changed the composition of its SOMA portfolio to control long-term interest rates and the overall financial condition of the market.

Agency Mortgage-Backed Securities

The Fed’s trading desk buys mortgage-backed securities or MBS that are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Usually, MBS purchases are made in recently produced coupons in the 30-year and 15-year fixed-rate agency MBS in the To-Be-Announced (TBA) market.

Commercial Mortgage-Backed Securities

Another instrument purchased in OMOs is Commercial Mortgage-Backed Securities or CMBS. These CMBS that are secured primarily by multi-family home mortgages are guaranteed fully (principal and interest) by Fannie Mae, Freddie Mac, and Ginnie Mae.

Temporary OMOs help the Fed react to transitionary reserve needs. They do this through repurchase agreements or REPOs and Reverse Repurchase Agreements or RRPs. The Trading Desk buys securities with the promise to resell it in the future. It functions like a collateralized loan, where the interest is the difference between purchase and sale prices. Reverse REPOS on the other hand works like collateralized borrowing by the Federal Reserve. These instruments help keep the targeted federal fund rate.