By Michael S. Derby 

The outstanding amount of temporary money the Federal Reserve has added to the financial system fell by a notable amount this week.

On Friday, the New York Fed executed a $26.24 billion repurchase agreement operation, or repo, that expires on Monday. Because $30.19 billion in outstanding repos were maturing Friday, the overall pool of temporary operations ticked down $4 billion to $126.2 billion. The drop Friday followed another big decline on Thursday, when the repo outstanings tumbled by $13.3 billion.

Outstanding repos are now at their lowest level since nearly the time that the Fed restarted the temporary interventions last fall after a decade of disuse. The Fed redeployed repos last September after unexpected friction in the broader repo market, where banks and others go to borrow and lend cash short-term, causing it to briefly lose control of its short-term target rate range.

Fed repo operations, which were joined by central bank Treasury bill buying in October, were collectively designed to ensure banks have enough reserves to avoid unwanted volatility in short-term rates. Repo operations peaked on Jan. 1 with $255.62 billion outstanding.

At the Fed's policy meeting in late January it affirmed plans to wind down its Treasury bill buying in the second quarter and to likely end repo interventions in April. To that end, the Fed has reduced the maximum size of overnight operations to $100 billion, with the most latest longer-term repo operation capped at $25 billion. It will shrink to a $20 billion limit on Tuesday.

While most Fed officials have rejected this view, many in markets said the Fed's temporary money, which helped lift the overall size of its balance sheet from $3.8 trillion in September to its current $4.2 trillion size, was a stealth form of stimulus generating unwarranted risk taking in financial markets. The Fed countered that it simply needed to bolster bank reserves to a minimum of $1.5 trillion. Now, bank reserve levels are at $1.7 trillion, giving the Fed a growing cushion for its reserves threshold.

At the same time, eligible banks' demand for the Fed's money has grown quite weak for overnight repos, although the term operations have pretty consistently seen banks seek more money than the Fed would offer. Fed officials judge the success of the effort on what has happened with the federal-funds rate, and there, that rate has traded consistently where Fed officials want.

Fed repo operations and the state of its balance sheet have drawn less focus as the coronavirus health scare has raised fears about the global economic outlook, and sent stock prices plummeting and Treasury borrowing costs to historic lows. Markets broadly expect the Fed to lower rates in response to the trouble, even as Fed officials refrain from endorsing that view.

But if the Fed does lower rates, the balance sheet could loom back into view quickly. Any push to lower rates would bring monetary policy once again back toward near zero rates. Fed officials have already said they would use all the tools at their disposal should they deem it necessary. That could muddy the waters between its technical efforts to grow the balance sheet, and stimulus related buying, if it comes to that.

So far, that situation seems unlikely, but the outlook can change quickly.

Federal Reserve Bank of St. Louis President James Bullard said Friday "the situation is very fluid, and we are going to want to monitor events right up until" the mid-March Federal Open Market Committee meeting. "Further policy rate cuts are a possibility if a global pandemic actually develops with health effects approaching the scale of ordinary influenza, but this is not the baseline case at this time."

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

February 28, 2020 13:47 ET (18:47 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.