Fed Shrinking it's Balance Sheet
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I'd bet a dime that what you posted is not making you money trading. Just a bet. Want to double or nothing at $.20?
When the Fed stops net bond buying and shifts to net selling which it will do as it "normalizes" its balance sheet over the coming years the effect will be a slow gradual climb in interest rates. The Fed's main interest rate tool is the Fed Funds Rate which may be seen as the wholesale price of money. The rates bank charge for shorter term loans is a markup on the funds rate. The primary tool the Fed uses for maintaining the funds rate is to control the aggregate balance of reserve accounts by selling or buying bonds, and other measures. Aggregate Balances above the 10% reserve requirement put downward pressure on the wholesale cost of money (Fed Funds Rate) In fact as the aggregate reserve account balance rises above the 10% requirement, the Funds rate is driven rapidly toward zero. This happened by design during the financial crisis when the Fed intentionally allowed reserve balances to rise --normally they keep the aggregate value exactly constant to the penny -- well above the required minimum and we saw the wholesale rate of money plummet rapidly toward zero. To prevent it from going all the way to zero, the Fed begin to pay a small interest on reserves, something they normally do not do. This put a floor under interest rates just a little above zero. The fed also begin using proceeds from matured short term bonds to buy the long bond ("operation twist," or qualitative easing). They eventually bought about 400 billion in long bonds. This had the affect of propping up the long bond price and holding down long term interest rates, and thus mortgage rates which are tied to the long bond. This was part of their program to rescue the real estate market and keep home owners in their homes by preventing adjustable rate mortgages from resetting higher.
The combined action of both quantitative and qualitative easing, together with extraordinary measures taken by the U.S. Treasury was successful in preventing what could have easily become another world wide depression! Normally the Fed has good control of short term rates but only an indirect affect on long term rates, however the overall effect of the Feds actions during the financial crisis was to reduce the price of both short and long term money, rescue the real estate industry, keep homeowners in their homes and encourage business borrowing and expansion. However the very deep recession made businesses reluctant to borrow despite the extraordinary low rates and reserve balances remained higher for a long time than the Fed thought desirable. They were well above the 10% requirement. And interest rates remained extraordinarily low.
Now, as the Fed begins to unwind their bond purchases, they may become a net sellers of bonds in the secondary market. The Fed's counterparty's transactions will clear through reserve accounts reducing the amount of money in bank reserves which will in the natural course of events result in upward pressure on the Fed Funds rate which is exactly what the Fed intends and has in fact announced. Going forward you can expect a series of 25 basis point rises in the Funds rate. Short term loan rates will rise.
Fed bond sales will prevent bond prices from rising much, depending on business conditions and the equities market, and should depress bond prices some. On the other hand as bond prices come down, rates will naturally rise accordingly. The Fed will do this, as they always do, at a slow well considered pace. And they will adjust the rate at which they divest according to economic conditions.
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There is nothing to stop the Fed from letting bonds mature and returning the proceeds to the Treasury side of the consolidated Fed-Treasury balance sheet. Or alternatively the proceeds can be returned to whence they came, the air.
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POMO days and net monthly purchases were comparatively aggressive. I seem to recall 80 billion / month QE3. Reserve levels were not so closely monitored and considered as late as early 2013 in that direction. Floodgates were open.
As for the balance sheet reduction....
10 bil/ month retired is probably about half the total maturities for 2018(dont want to look it up) . So, net, the fed will still re-invest( purchase treasuries) possibly 1/7 of the 2018 US government debt if one estimates an 800 bil. deficit. A buyer of treasuries a seller of none.
Excuse the estimated figures but the point is clear....It's a big NothingBurger but maybe a tool whose suspension can jack the Dow 250.
IMO regarding rates etc...
Seems maturity is naturally increasing with the fed slowly acting on the fed funds rate so flattening continues.
How can one construe anything happening in the longer maturities to the fed balance sheet reduction?. Its not uncommon, in a sample of two, (dot com and 2007)that long bond rates are deflated as the fed tightens.
As for predictimg what is to be..
Remember 2014. Market pundits spoke of taper, a divergent US , tightening , monetary policy and expected interest rates rising.
Bond market prices went the other way and continued deflation ruled.
No one knows where prices will go despite the PHd's etc...
Fhl......amazing table. This is the new normal. Can anyone sell an equity an endure the punishment of a cash position..
Seems to me that zippers are down but everyone is happy with the breeze.
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A little clarification when I said a "buyer of treasuries a seller of none".
I think deficits will be high in the Trump presidency. A low cost is important to the treasury to finance their borrowing. I have heard of tricks prior to auctions to bump yields down. They are very competitive. I dont think the fed will be a competitive seller of thentreasury and bump the cost(yields) up. I will assume they will choose to cancel ancreditnin reserves held at the fed with keystroke instead. So therefore, "the seller of none"
That leaves the re-investment of (2018 maturities-10/bil per month.) Maybe 100 billion net of treasuries that the fed purchase for 2018 assisting in holding the cost(rate) down.
Remember, I am an amateur that can talk smack and shoot from the hip so apologies to the
precise professionals . It's a double nothing burger with cheese. Understandably reserve levels will settlehigher since total reduction would take 40 years witout interruption.
I think deficits will be high in the Trump presidency. A low cost is important to the treasury to finance their borrowing. I have heard of tricks prior to auctions to bump yields down. They are very competitive. I dont think the fed will be a competitive seller of thentreasury and bump the cost(yields) up. I will assume they will choose to cancel ancreditnin reserves held at the fed with keystroke instead. So therefore, "the seller of none"
That leaves the re-investment of (2018 maturities-10/bil per month.) Maybe 100 billion net of treasuries that the fed purchase for 2018 assisting in holding the cost(rate) down.
Remember, I am an amateur that can talk smack and shoot from the hip so apologies to the
precise professionals . It's a double nothing burger with cheese. Understandably reserve levels will settlehigher since total reduction would take 40 years witout interruption.
It will be a very slow process... Reserves will shrink probably by a factor of 2. The Fed will reinvest progressively less and less. That’s it, nothing really much to it other than that.
Yes, most likely!
