The QE unwind has started to rattle some nerves.
For the past two months, the sound of wailing and gnashing of teeth about
the Fed’s QE unwind has been deafening. The Fed started the QE unwind in
October 2017. As I covered it on a monthly basis, my ruminations on how it would unwind
part of the asset-price inflation and Bernanke’s “wealth effect” that had
resulted from QE were frequently pooh-poohed. They said that the truly
glacial pace of the QE unwind was too slow to make any difference; that QE
had just been a “book-keeping entry,” and that therefore the QE unwind would
also be just a book-keeping entry; that QE had never caused any kind of asset
price inflation in the first place, and that therefore the QE unwind would
not reverse that asset-price inflation, or whatever.
But in October last year, when all kinds of markets started reversing this
asset price inflation, suddenly, the QE unwind got blamed, and the Fed –
particularly Fed Chairman Jerome Powell – has been put under intense pressure
to cut it out. Yet it continues:
The Fed shed $28 billion in assets over the four weekly balance-sheet
periods of December. This reduced the assets on its balance sheet to $4,058
billion, the lowest since January 08, 2014, according to the Fed’s balance
sheet for the week ended January 3. Since the beginning of this “balance sheet
normalization,” the Fed has now shed $402 billion.
According to the Fed’s plan released when the QE unwind was introduced,
the Fed is scheduled to shed “up to” $30 billion in Treasuries and “up to”
$20 billion in MBS a month – now that the QE unwind has reached cruising
speed – for a total of “up to” $50 billion a month. So how did it go in
December?
Treasury Securities
Over the four weeks from December 6 through January 3, the Fed’s holdings
of Treasury securities fell by $18 billion to $2,223 billion, the lowest
since January 15, 2014. Since the beginning of the QE-Unwind, the Fed has
shed $243 billion in Treasury securities:
The Fed sheds Treasury securities not by selling them but by allowing them
to “roll off” without replacement when they mature. When Treasury securities
mature, the Treasury Department transfers money in the amount of face value
plus any outstanding interest to all holders of those securities. The fact
that Treasuries mature mid-month or at the end of the month creates the
step-pattern of the QE unwind in the chart above.
On December 15, no Treasuries in the Fed’s portfolio matured. On December
31, three issues matured, totaling $18 billion. This did not reach the cap of
$30 billion. So for the month, all $18 billion in Treasury securities that
matured were allowed to roll off without replacement. And the Treasury
Department paid the Fed for them.
The Fed creates money, and it destroys money; but it doesn’t hold
trillions of dollars in cash. So when it received the $18 billion from the Treasury
Department, it destroyed them just as it had created them to purchase these
securities during QE.
For those wailing and gnashing their teeth about the QE unwind: Going
forward, there will not be all that many months when enough Treasuries mature
to reach the cap of $30 billion. For example, in January the Fed’s maturity
schedule shows that four bond issues will mature totaling only $13.3 billion,
including one issue of TIPS.
Mortgage-Backed Securities (MBS)
The residential MBS that the Fed acquired as part of QE were issued and
guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Holders of these MBS
receive principal payments as the underlying mortgages are paid down or are
paid off. The remaining principal is paid off at maturity. To keep the balance
of MBS from declining after QE had ended, the New York Fed’s Open Market
Operations continued purchasing MBS in the market.
The Fed books MBS trades at settlement, which lags the trade by two to
three months. Due to this lag, the amount of MBS on the weekly balance sheets
in December reflected trades in September and October. In September, which
was the last month of the ramp-up period, the cap for shedding MBS was $16
billion. In October, the cap rose to $20 billion.
In December, the balance of MBS fell by $16 billion, to $1,653 billion,
back where it had been on April 13, 2014. Since the beginning of the QE
unwind, the Fed has shed $133 billion in MBS:
So December was a somewhat slow month for the QE unwind, with $18 billion
in Treasury securities and $16 billion in MBS rolling off the balance sheet,
for a total of $34 billion that went back where it had come from during QE –
namely ambient air.
Investors are waking up after years of central-bank inspired somnolent
money-making. Read… Markets
Are in a Tizzy. So What Will the Fed Do?
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