The Fed just made an overlooked decision that's even more important than its last rate cut

• Investors got their desired rate cut last week, but another Fed move might be more important.
• The Fed has begun "reserve management purchases," buying $40 billion a month in short-term Treasurys.
• Here's why that's a big deal for markets.

The most important part of the Fed's last policy meeting is something that may have been overshadowed by the eagerly awaited rate cut.

The central bank's decision to start "reserve management purchases," a mouthful that essentially boils down to the Fed expanding its balance sheet by purchasing short-term US Treasurys, is a big deal for markets.

Changes to the Fed's balance sheet often fly under the radar for many investors, who primarily trade based on rate cuts and expectations for the path of monetary policy. Yet, the central bank's bond purchase programs have historically been an important tool for both influencing interest rates as well as providing liquidity to markets.

The announcement of a new bond-buying initiative was likely one of the most important details of last week's meeting, according to Steven Blitz, a managing director and chief US economist at TS Lombard.

"The Fed cut and said 'that's all folks' until the data roll in, but that was no surprise and far less important than the signalling from the return of balance sheet purchases," Blitz wrote.

Here's what's happening and why it's a big deal for markets.

What are reserve management purchases?

In its statement last Wednesday, the FOMC said it believed the Fed's reserve balances had declined to "ample levels," and that it would start purchasing short-term US Treasurys "on an ongoing basis" starting at the end of the week.

The Fed will buy about $40 billion of Treasurys a month before tapering off in the spring. Reserve balances at the Fed dropped to a low of $2.8 trillion in October, its lowest level in nearly three years.

It's slightly different than the Fed's quantitative easing program, which is aimed explicitly at stimulating economic activity. The latest purchase program, meanwhile, is meant to ensure stability in financial markets.

Why is it important to markets?

There are a few reasons the move is important for markets and investors.

Funding relief

Low bank reserves can add to short-term funding pressures in the financial system. The Fed's RMP program is therefore a technical function of the central bank, rather than an update to any aspect of monetary policy. Still, it has implications for markets.

It became easier for banks, brokers, and other market participants to borrow short-term funds last week. The Secured Overnight Financing Rate dropped from 3.9% last Wednesday to 3.67% by the end of the week. That's the lowest the rate has been in about three years, according to New York Fed data.

Some market pundits have said the move raises concerns about the health of the banking system. Michael Burry, the investor of "The Big Short" fame, said he believed the fact that the Fed has to provide liquidity support at all is a worrying sign.

"I would add if the US banking system can't function without $3+ trillion in reserves/life support from the Fed, that is not a sign of strength but a sign of fragility," Burry wrote in a post on X Wednesday evening. "So I'd say US Banks are getting weaker way too fast."

Still, others view it as a necessary function of the central bank as it seeks to ensure market stability.

"Moderate balance sheet expansion will be necessary to accommodate the increased demand for reserves that accompanies ongoing economic growth," strategists at Glenmede wrote in a recent note.

Implications for markets

The start of RMPs marks the first time the Fed has meaningfully expanded its balance sheet since it ended its quantitative easing program in 2022, Deutsche Bank said.

"The 25bp cut is mostly in line with expectations, but the start of treasury purchasing ($40bn) is what drove the market reaction," analysts at JPMorgan wrote in a note following the Fed meeting, pointing to the move up in stocks.

Morgan Stanley echoed that, noting that while the Fed has emphasized RMPs are not QE, the result of added liquidity is ultimately similar.

"More importantly, these purchases provide additional liquidity for markets, and in combination with rate cuts, also suggest the Fed is likely less worried about missing its inflation target," the bank wrote on Monday.

Bank of America said that the "QE-like" impact on markets could result in bond yields at the longer end of the duration curve coming down as well.

In BofA's baseline scenario, which includes the Fed making around $380 billion worth of reserve management purchases in 2026, strategists expect the 10-year US Treasury yield to decline by 20 to 30 basis points.

That's bullish for two reasons. Lower bond yields in general encourage investors to stick with equities for better returns, but a lower 10-year yield specifically means potentially easier borrowing conditions for consumers and businesses.

"Fed's RMP program will increase general market liquidity," BofA strategists wrote of the bond market in a separate note last week. "With the Fed action, the market is on better footing and the large calendar to end the year should be bought."