Tag Archives: QE

The Fed Accelerates its QE Unwind

Mopping up liquidity.

The Fed’s QE Unwind – “balance sheet normalization,” as it calls this – is accelerating toward cruising speed. The first 12 months of the QE unwind, which started in October 2017, are the ramp-up period – just like there was the “Taper” during the final 12 months of QE. The plan calls for shedding up to $420 billion in securities in 2018 and up to $600 billion a year in each of the following years until the balance sheet is sufficiently “normalized” – or until something big breaks.

Treasuries

In July, the QE Unwind accelerated sharply. According to the plan, the Fed was supposed to shed up to $24 billion in Treasury Securities in July, up from $18 billion a month in the prior three months. And? The Fed released its weekly balance sheet Thursday afternoon. Over the four weeks ending August 1, the balance of Treasury securities fell by $23.5 billion to $2,337 billion, the lowest since April 16, 2014. Since the beginning of the QE-Unwind, the Fed has shed $129 billion in Treasuries.

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-Treasuries.png

The step-pattern in the chart above is a result of how the Fed sheds Treasury securities. It doesn’t sell them outright but allows them to “roll off” when they mature. Treasuries only mature mid-month or at the end of the month. Hence the stair-steps.

In mid-July, no Treasuries matured. But on July 31, $28.4 billion matured. The Fed replaced about $4 billion of them with new Treasury securities directly via its arrangement with the Treasury Department that cuts out Walls Street (its “primary dealers”) with which the Fed normally does business. Those $4 billion in securities, to use the jargon, were “rolled over.” But it did not replace about $24 billion of maturing Treasuries. They “rolled off.”

Mortgage-Backed Securities

Under QE, the Fed also bought mortgage-backed securities, which were issued and guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Holders of residential MBS receive principal payments as the underlying mortgages are paid down or are paid off. At maturity, the remaining principal is paid off.  So, to keep the MBS balance from declining on the Fed’s balance sheet after QE ended, the New York Fed’s Open Market Operations (OMO) kept buying MBS.

Settlement of those trades occurs two to three months later. Since the Fed books the trades at settlement, there’s a lag of two to three months between the date of the trade and when the trade appears on the Fed’s balance sheet [here’s my detailed explanation]. This is why it took a few months before the QE unwind in MBS showed up distinctively on the balance sheet.

The current changes of MBS on the balance sheet reflect trades from about two months ago. At the time, the cap for shedding MBS was $12 billion a month. And? Over the past four weeks, the balance of MBS fell by $11.8 billion, to $1,710 billion as of August 1, the lowest since October 8, 2014. In total, $61 billion in MBS have been shed since the beginning of the QE unwind:

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-MBS.png

Total Assets on the Balance Sheet

QE only involved Treasuries and MBS. And so the QE unwind only involves Treasuries and MBS. Since the beginning of the QE Unwind, Treasuries dropped by $129 billion and MBS by $61 billion, for a combined decline of $190 billion.

But the balance sheet of the Fed also reflects the Fed’s other functions and activities. And the decline in the overall balance sheet is not going to reflect exactly the amounts shed in Treasuries and MBS.

Total assets on the Fed’s balance sheet for the four weeks ending August 1 dropped by $34.1 billion. This brought the drop since October, when the QE unwind began, to $205 billion. At $4,256 billion, total assets are now at the lowest level since April 9, 2014, during the middle of the “taper.” It took the Fed about six years to pile on these securities, and now it’s going to take years to shed them:

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-overall.png

So the pace of the QE Unwind has accelerated in July, as planned. The Fed has not blinked during the sell-offs in the market, and it’s not going to. It is targeting “elevated” asset prices and financial conditions. Asset prices remain elevated and financial conditions remain ultra-loose. Markets have essentially brushed off the Fed so far. And that only acts as an encouragement for the Fed to proceed.

The FOMC, in its August 1 statement, mentioned “strong” five times in describing various aspects of the economy and the labor market – the most hawkish statement in a long time. Rate hikes will continue, and the pace might pick up. And the QE unwind will accelerate to final cruising speed and proceed as planned. The Fed stopped flip-flopping in the fall of 2016 and hasn’t looked back since.

When the economy eventually slows down enough to where the Fed feels like it needs to act, it will cut rates, but it will let the QE unwind proceed on automatic pilot toward “normalization,” whatever that will mean. That’s the stated plan. And the Fed will stick to it – unless something big breaks, such as credit freezing up again in the credit-dependent US economy, at which point all bets are off.

Source: by Wolf Richter | Wolf Street

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Exploring The Death Spiral Of Financialization [video]

Each new policy destroys another level of prudent fiscal/financial discipline.

The primary driver of our economy–financialization–is in a death spiral. Financialization substitutes expansion of interest, leverage and speculation for real-world expansion of goods, services and wages.

Financial “wealth” created by leveraging more debt on a base of real-world collateral that doesn’t actually produce more goods and services flows to the top of the wealth-power pyramid, driving the soaring wealth-income inequality we see everywhere in the global economy.

As this phantom wealth pours into assets such as stocks, bonds and real estate, it has pushed the value of these assets into the stratosphere, out of reach of the bottom 95% whose incomes have stagnated for the past 16 years.

The core problem with financialization is that it requires ever more extreme policies to keep it going. These policies are mutually reinforcing, meaning that the total impact becomes geometric rather than linear. Put another way, the fragility and instability generated by each new policy extreme reinforces the negative consequences of previous policies.

These extremes don’t just pile up like bricks–they fuel a parabolic rise in systemic leverage, debt, speculation, fragility, distortion and instability.

This accretive, mutually reinforcing, geometric rise in systemic fragility that is the unavoidable output of financialization is poorly understood, not just by laypeople but by the financial punditry and professional economists.

Gordon Long and I cover the policy extremes which have locked our financial system into a death spiral in a new 50-minute presentation, The Road to Financialization. Each “fix” that boosts leverage and debt fuels a speculative boom that then fizzles when the distortions introduced by financialization destabilize the real economy’s credit-business cycle.

Each new policy destroys another level of prudent fiscal/financial discipline.

The discipline of sound money? Gone.

The discipline of limited leverage? Gone.

The discipline of prudent lending? Gone.

The discipline of mark-to-market discovery of the price of collateral? Gone.

The discipline of separating investment and commercial banking, i.e. Glass-Steagall? Gone.

The discipline of open-market interest rates? Gone.

The discipline of losses being absorbed by those who generated the loans? Gone.

And so on: every structural source of discipline has been eradicated, weakened or hollowed out. Financialization has consumed the nation’s seed corn, and the harvest of instability is ripening in the fields of finance and the real economy alike.

Source: ZeroHedge

Foreign Governments Dump US Treasuries as Never Before, But Who the Heck is Buying Them?

It started with a whimper a couple of years ago and has turned into a roar: foreign governments are dumping US Treasuries. The signs are coming from all sides. The data from the US Treasury Department points at it. The People’s Bank of China points at it in its data releases on its foreign exchange reserves. Japan too has started selling Treasuries, as have other governments and central banks.

Some, like China and Saudi Arabia, are unloading their foreign exchange reserves to counteract capital flight, prop up their own currencies, or defend a currency peg.

Others might sell US Treasuries because QE is over and yields are rising as the Fed has embarked on ending its eight years of zero-interest-rate policy with what looks like years of wild flip-flopping, while some of the Fed heads are talking out loud about unwinding QE and shedding some of the Treasuries on its balance sheet.

Inflation has picked up too, and Treasury yields have begun to rise, and when yields rise, bond prices fall, and so unloading US Treasuries at what might be seen as the peak may just be an investment decision by some official institutions.

The chart below from Goldman Sachs, via Christine Hughes at Otterwood Capital, shows the net transactions of US Treasury bonds and notes in billions of dollars by foreign official institutions (central banks, government funds, and the like) on a 12-month moving average. Note how it started with a whimper, bounced back a little, before turning into wholesale dumping, hitting record after record (red marks added):

https://i1.wp.com/wolfstreet.com/wp-content/uploads/2017/02/US-Treasuries-net-foreign-transactions.png

The People’s Bank of China reported two days ago that foreign exchange reserves fell by another $12.3 billion in January, to $2.998 trillion, the seventh month in a row of declines, and the lowest in six years. They’re down 25%, or almost exactly $1 trillion, from their peak in June 2014 of nearly $4 trillion (via Trading Economics, red line added):

https://i1.wp.com/wolfstreet.com/wp-content/uploads/2017/02/China-Foreign-exchange-reserves-2017-01.png

China’s foreign exchange reserves are composed of assets that are denominated in different currencies, but China does not provide details. So of the $1 trillion in reserves that it shed since 2014, not all were denominated in dollars.

The US Treasury Department provides another partial view, based on data collected primarily from US-based custodians and broker-dealers that are holding these securities for China and other countries. But the US Treasury cannot determine which country owns the Treasuries held in custodial accounts overseas. Based on this limited data, China’s holdings of US Treasuries have plunged by $215.2 billion, or 17%, over the most recent 12 reporting months through November, to just above $1 trillion.

So who is buying all these Treasuries when the formerly largest buyers – the Fed, China, and Japan – have stepped away, and when in fact China, Japan, and other countries have become net sellers, and when the Fed is thinking out loud about shedding some of the Treasuries on its balance sheet, just as nearly $900 billion in net new supply (to fund the US government) flooded the market over the past 12 months?

Turns out, there are plenty of buyers among US investors who may be worried about what might happen to some of the other hyper-inflated asset classes.

And for long suffering NIRP refugees in Europe, there’s a special math behind buying Treasuries. They’re yielding substantially more than, for example, French government bonds, with the US Treasury 10-year yield at 2.4%, and the French 10-year yield at 1.0%, as the ECB under its QE program is currently the relentless bid, buying no matter what, especially if no one else wants this paper. So on the face of it, buying US Treasuries would be a no-brainer.

But the math got a lot more one-sided in recent days as French government bonds now face a new risk, even if faint, of being re-denominated from euros into new French francs, against the will of bondholders, an act of brazen default, and these francs would subsequently get watered down, as per the euro-exit election platform of Marine Le Pen. However distant that possibility, the mere prospect of it, or the prospect of what might happen in Italy, is sending plenty of investors to feed on the richer yields sprouting in less chaos, for the moment at least, across the Atlantic.

By Wolf Richter | Wolf Street

Why US Stock And Bond Markets Are High

We’ve been saying for quite some time now that the US equity market’s seemingly inexorable (until this week) tendency to rise to new highs in the absence of the Fed’s guiding hand is almost certainly in large part attributable to the fact that in a world where you are literally guaranteed to lose money if you invest in safe haven assets such as negative-yielding German bunds, corporations can and will take advantage of the situation by issuing debt and using the proceeds to buy back stock, thus underwriting the rally in US equities. Here’s what we said after stocks turned in their best month in three years in February:

It also explains why, in the absence of the Fed, stocks continue to rise as if QE was still taking place: simply said, bondholders – starved for any yield in an increasingly NIRP world – have taken the place of the Federal Reserve, and are willing to throw any money at companies who promise even the tiniest of returns over Treasuries, oblivious if all the proceeds will be used immediately to buyback stock, thus pushing equity prices even higher, but benefiting not only shareholders but management teams who equity-linked compensation has likewise never been higher.

If you need further proof that this is precisely what is going on in US markets, consider the following from Citi: 

Companies are rapidly re-leveraging…

…and the proceeds sure aren’t being invested in future productivity, but rather in buy backs and dividends…
https://i2.wp.com/www.zerohedge.com/sites/default/files/images/user92183/imageroot/2015/03/Leverage2.jpg
…and Citi says all that debt issued by struggling oil producers may prove dangerous given that “default risk in the energy space has jumped [and considering] the energy sector now accounts for 18% of the market”…
…and ratings agencies are behind the curve…
https://i2.wp.com/www.zerohedge.com/sites/default/files/images/user92183/imageroot/2015/03/Leverage4.jpg
We’ll leave you with the following:

To be sure, this theater of financial engineering – because stocks are not going up on any resemblance of fundamental reasons but simply due to expanding balance sheet leverage – will continue only until it can no longer continue.

Read more at Zero Hedge

Long-Term Interest Rates Are Down This Year – Why?

By Gary Halbert

Back in December when the Fed started its “tapering” operation, with the goal of terminating it by the end of 2014, it was only natural to assume that the Fed’s retreat would result in higher yields this year, especially on long-maturity Treasuries and mortgage-backed securities (MBS).

After all, the Fed has been the largest buyer of Treasuries and MBS in the history of the world since it began its “quantitative easing” (QE) program in late 2008. At that time, the Fed had apprx. $750 billion worth of Treasuries and MBS on its balance sheet. Today, that number is north of $4 trillion! Of this amount, over half ($2.4 trillion) is in long-dated Treasuries. QE has been the largest central bank asset purchase program ever recorded by far.

By late 2012, the Fed’s purchases of long-dated Treasuries and MBS climbed to a staggering $85 billion per month – just over $1 trillionadded in 2013 alone. The Fed has been reducing these monthly asset purchases by $10 billion at each policy meeting since last December. Following the last policy meeting on June 17-18, the Fed’s QE purchases are now down to $35 billion per month. The plan is that these purchases will wind-down to zero before the end of this year.

Virtually every forecaster I read predicted that the Fed’s withdrawal from QE would result in higher interest rates for long-dated Treasuries and mortgage rates. Yet to the surprise of just about everyone, longer-term Treasury yields have plunged this year.

Fig2

The Problem: A Shortage of Long-Dated Bonds

One reason that Treasury yields have fallen significantly this year is that there is a shortage of long-dated Treasuries. The Fed is partly to blame. Through its massive QE purchases of Treasuries and MBS, the Fed now owns about 20% of all Treasuries, or $2.4 trillion. Banks, on the other hand, hold only $547 billion of tradable Treasuries and government agency-related debt.

In addition, the Fed’s holdings have shifted in ways that leave fewer central-bank-owned Treasuries available to be borrowed. This shift was caused by “Operation Twist” during the November 2011 to December 2012 period when the Fed sold shorter-dated Treasuries and bought more longer-dated bonds, which reduced the available pool of long bonds even more.

Adding to the problem, major US banks have also increased their purchases of Treasury debt, in part due to the Dodd-Frank law that was supposedly designed to limit risk taking by large US banks. Demand for Treasuries from large pension funds and foreign investors has also increased this year. Also, some of the outsized gains from the stock market last year have made their way into Treasuries.

Finally, the government itself has been selling fewer Treasuries in recent years as the federal budget deficits have fallen significantly. During the Great Recession, budget deficits ran over $1 trillion a year. The budget deficit for FY2012 was $1.1 trillion. However, in FY2013 the deficit fell sharply to $680 billion, down 37%.

For FY2014, the Congressional Budget Office estimates that the deficit will fall even further to $492 billion, and many believe it will be closer to $400 billion, as the economy shows more signs of strength. For FY2015, the deficit is expected to be $462 billion or less.

The point is, with budget deficits less than half of the $1 trillion or so that they were in President Obama’s first term, the government is selling less than half the amount of Treasuries it was just a few years ago. This, too, adds to the shortage of Treasuries.

The bottom line: When Treasuries are in short supply and demand is strong
as it has been this year, buyers bid up the prices of these securities. When
bond prices go up, yields fall.

This helps explain why interest rates have come down this year at a time when almost everyone expected them to rise. It also explains why the Fed would like investors to sell their bonds to help alleviate the shortage. Of course, Fed Chair Janet Yellen would never say that!

It remains to be seen if this trend of lower interest rates will continue as the economy gathers momentum. While I didn’t mention it above, no one expected the economy to tank 2.9% in the 1Q and this, too, helped bring interest rates down more than expected.

As you can see in the chart above, the 30-year T-bond yield bottomed in late May at 3.30% and has been rising since then. If the first estimate of 2Q GDP comes in above 3% on July 30, I would expect that we’ve seen the bottom in long rates for this cycle.

Update: for a deeper look at this issue, click here for an Zero Hedge article on this topic.