Taper, What Taper?

By: Steve Sosnick, Chief Strategist at Interactive Brokers

The Federal Reserve has been tapering its bond purchases, right? Oh really? How do they explain this?

Federal Reserve Securities Held Outright, Weekly Wednesday Closes, with 4-Week (yellow) and 10-week (magenta) Moving Averages

(Click on image to enlarge)

Source: Bloomberg

Here is a quick explanation of the chart above. Every Thursday afternoon, the Federal Reserve issues a report on the factors influencing reserve balances, known as the H.4.1 report. If you click on one of the weekly reports, you will see that the last column in the second row of numbers is the amount of securities held outright by the Fed as of the Wednesday immediately prior to that report. The chart shows the value of that statistic in each weekly report. 

If the Fed was really tapering its bond purchases we would expect to see these values declining, not rising at a generally the same linear rate as it was for the year prior. Slowing purchases would cause each of the lines to slow their ascent. The 4-week moving average should be converging with the 10-week if the monthly purchases slowed. Yet that is not the case!

At each of the past three FOMC meetings, we were told to expect that they would reduce their purchases of securities. From the November 2021 FOMC Statement:

“…the Committee decided to begin reducing the monthly pace of its net asset purchases by $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities. Beginning later this month, the Committee will increase its holdings of Treasury securities by at least $70 billion per month and of agency mortgage‑backed securities by at least $35 billion per month. Beginning in December, the Committee will increase its holdings of Treasury securities by at least $60 billion per month and of agency mortgage-backed securities by at least $30 billion per month.”

From the December 2021 FOMC Statement:

“In light of inflation developments and the further improvement in the labor market, the Committee decided to reduce the monthly pace of its net asset purchases by $20 billion for Treasury securities and $10 billion for agency mortgage-backed securities. Beginning in January, the Committee will increase its holdings of Treasury securities by at least $40 billion per month and of agency mortgage‑backed securities by at least $20 billion per month.”

And from the January 2022 FOMC Statement:

“The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March. Beginning in February, the Committee will increase its holdings of Treasury securities by at least $20 billion per month and of agency mortgage‑backed securities by at least $10 billion per month.”

If we follow through with this logic, we would have expected to see the holdings of securities on the Fed’s balance sheet to grow at a decreasing rate. The Fed was committed to buying about $120 billion in bonds each month over the past year and a half through November. The ratio was 2/3 Treasury securities and 1/3 mortgage securities, or $80 and $40 billion respectively. Based upon the statements referenced above, we would have expected to see the 4-week moving average (representing about a month) grow at $120 billion prior to November, then $105 billion in November/December, $90 billion in December/January, then $60 billion and $30 billion in the coming months. But the holdings are still growing at about $120 billion/month!

I bet you missed the 2 keywords in each of those statements that prevents us from calling the FOMC a bunch of liars: “at least.”The markets focused on the minimum amount of purchases that would be occurring each month. Meanwhile, the Fed continued to buy bonds at roughly the same pace as before. That seems like a bit of subterfuge, no?

I believe that the implications for investors are quite clear. We have seen increased volatility in stock and bond markets as the Fed’s rhetoric veers away from continual stimulus. But they haven’t yet begun to remove that stimulus, only discussed it. We would expect markets to continue to wobble further when the Fed finally decides to actually remove their training wheels. So far it’s been watch what I say, not what I do. Be wary once they actually do what they say.