Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The Federal Reserve has said it will launch a $40bn short-term bond-buying programme just weeks after it stopped shrinking its balance sheet following repeated bouts of strain in money markets.

The US central bank said on Wednesday it would begin purchasing Treasury bills, debt that matures in four weeks to a year, starting on December 12.

Its decision comes after interest rates in overnight lending markets jumped last month as the Fed’s three-year efforts to shrink its balance sheet absorbed excess liquidity from markets.

Some Fed officials had expressed concern that rates in the repo market, which forms a vital part of the financial system’s plumbing, had repeatedly become unmoored from other borrowing costs the central bank sets.

The Fed halted its quantitative tightening programme on December 1, but many in the market viewed that as insufficient to steady funding markets.

The Fed was expected by some on Wall Street to announce a Treasury bill-buying programme on Wednesday, but the pace and size of the purchases were more aggressive than projected, suggesting the Fed was uneasy about the volatility in short-term funding markets in recent months.

The Fed said these purchases “will remain elevated for a few months” ahead of April, the month when many Americans make tax payments, sucking reserves out of the banking system.

Fed chair Jay Powell said on Wednesday that because the central bank was monitoring reserve levels, “we knew this was going to come. When it finally did come, it came a little quicker than expected but we were absolutely there to take the actions that we said we would take.”

Powell stressed that the bond purchases were not part of the Fed’s monetary policy mix and did not mark a return to large-scale purchases of long-term debt used to stimulate the economy.

The Fed’s quantitative tightening programme had returned more government debt to private markets, depleting bank reserves. The 2019 repo crisis, in which a scarcity of reserves sent repo rates above 10 per cent, ended the Fed’s previous quantitative-tightening initiative.

Jefferies chief economist Thomas Simons said the scale of the bond-buying programme was in line with his expectations. He said it was “a good move to get out ahead of a crisis like 2019”.

“This is very reminiscent of 2019 where the Fed overshot by reducing the balance sheet too much. This is the Fed saying that they may have overshot a little bit, and now they’re just topping up,” said Calvin Tse, head of US strategy and economics at BNP Paribas.

The repo market allows banks and other financial institutions to borrow cash overnight in exchange for ultra-safe collateral such as Treasuries. The cash loaned out overnight is often “excess” bank reserves, which refers to money kept on hand by banks to meet customer and regulatory demands.

When those reserve levels fall, borrowing rates rise as banks compete for cash to meet their obligations, sending interest rates higher.