ORLANDO, Florida, Dec 9 (Reuters) - The Federal Reserve

is widely expected to trim interest rates on Wednesday, but if

Chair Jerome Powell wants to give markets an added holiday

surprise, here's one option: about $45 billion of monthly

short-term bill purchases.

That's the out-of-consensus call from Bank of America's

rates strategists. They agree that a quarter-percentage-point

reduction in the Fed funds target range to 3.50%-3.75% is

likely. They also reckon the Fed will announce it will start

buying large quantities of Treasury bills in January to maintain

"ample" reserves in the banking system and avert the kind of

liquidity crunch that froze money markets in September 2019.

Bank reserves peaked at $4.27 trillion in 2021, and have

recently fallen as low as $2.83 trillion.

To be clear, these so-called "Reserve Management Purchases"

(RMP) would not be quantitative easing.

That refers to central bank purchases of government bonds to

lower longer-dated yields and stimulate lending. Crucially, QE

is usually conducted in an economy where deflation is a greater

threat than inflation, and when interest rates are at or near

zero.

The RMP operation that BofA envisages doesn't meet any of

these criteria. It would be designed to manage money market

liquidity, ensuring the plumbing of the interbank market doesn't

suddenly clog up and imperil the functioning of the financial

system.

However, the Fed would leave itself open to accusations from

its raft of critics that, regardless of the name, this is just

the latest wave of money-printing madness that could accelerate

the march towards higher inflation and currency debasement.

But given ongoing concern about tightening liquidity in the

repo market and a sharp rise in Treasury bill issuance by

President Donald Trump's administration, this is a holiday gift

that both markets and the White House might be glad to receive.

'CERTAINTY AND CONFIDENCE'

This plan wouldn't come out of left field. Most Fed-watchers

already expect the central bank to begin buying bills in the

first half of next year, and the Fed has already announced in

October that it will redirect proceeds from its maturing

mortgage-backed securities (MBS) into bills. Analysts estimate

MBS reinvestments will amount to around $15 billion a month.

But BofA's call is notable both for the timing and the size

of the predicted purchases. The $45 billion haul would be on top

of the MBS reinvestments, meaning the Fed would soon be buying

around $60 billion of bills a month.

This will provide market participants with "certainty and

confidence" that reserves will remain "ample", according to BofA

rates strategist Mark Cabana, who previously worked on the New

York Fed's trading desk.

No one knows exactly how low reserves can get before

triggering a liquidity crisis and a spike in interbank borrowing

costs. But in September 2019 it was around $1.4 trillion, which

was roughly 6.5% of GDP at the time.

Padhraic Garvey at ING also reckons the Fed could announce

it will increase bank reserves by adding to the MBS roll-off

bill purchases.

As Garvey notes, if the Fed wants to keep the balance sheet

steady as a share of GDP, it will ultimately have to re-expand

at the same pace as nominal GDP growth. So if nominal GDP is

growing at 3-5%, bank reserves would need to increase at that

rate, which would equate to the Fed buying around $20-30 billion

of bills per month.

THE FED'S SHRINKING BALANCE SHEET

The Fed certainly has room to expand its balance sheet,

especially at the ultra-short end of the maturity spectrum. The

central bank's balance sheet stands at around $6.5 trillion,

down from a peak of $9 trillion in 2022. As a share of GDP,

which is the more relevant measure, it is now around 22%, down

from a peak of 35% also in 2022, and the smallest it's been

since April 2020.

Perhaps more importantly, bills only account for around 16%

of the Fed's balance sheet, roughly the same level as just

before the repo market crisis of September 2019.

Another 25-basis-point rate cut on Wednesday would be a

surprise to no one. If there are any fireworks from the Fed's

policy decision, they are more likely to be on the balance

sheet.

(The opinions expressed here are those of the author, a

columnist for Reuters)

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