Fed Balance Sheet Shrink: Big Problem Or Non-Event?
Dr. Yellen–What’s Next?
I’d like to begin this post with something I wrote June 17, 2013 (“The Dreaded Taper”).
“The Fed is buying $85.0 billion of intermediate to longer-term treasury securities and agency MBS per month, about $4.0 billion per day split evenly between the two classes. Meanwhile the Treasury is issuing $40.0 to $45.0 billion per month in new debt.Ergo, it can be said that the Fed is buying everything that Treasury is selling at a rate of $2.0 billion per day.However, there is an active market in U.S. Treasury securities averaging trading volume over $500 billion per day (you may find a current chart on Treasury market trading volume below).As to the agency MBS part of the equation, that market trades over $250 billion per day on average.The $2 billion going into this sector, again, is less than 1% of total volume.Against the backdrop of both markets $4 billion QE per day seems rather paltry.
Said another way, QE at $4 billion per day represents little more than 1/2 of 1 percent of incremental demand for longer-term government and agency MBS securities.It sounds like a big number, but in the context of a nearly $22 trillion combined market value and $750 billion combined daily combined trading volume, it is not.
If QE is withdrawn at the same pace that it was applied it will represent little more than half of one percent of incremental supply to the daily trade.This would seem to be the impending disaster that we will be faced with.To be sure rates will rise, and for all the right reasons, a stronger economy and a lessening of the fear that would lead an individual or institution to accept a 1.6% on a ten year note to get absolute guaranteed safety.”
I was right about everything above except the last part (interest rates rising). It seems that lower rates in many of the developed economies in Europe and Asia have made our treasuries magnetic for foreign investment. This coupled with many investors still fearful of stocks after their ‘horror show’ experience in 2008 has continued to keep our rates depressed. The rate on our 10-year TSY ended June of 2013 at 2.48%. Last Friday April 7, that rate was 2.38%. Whoda Thunk It?
Freaking out already!
Quantitative Easing (Q.E.) is a fertile field for the media
The reason that I bring this up is that four years ago the media created a major freak-out over Q.E., its creation and eventual tapering. I suspect that now that the Fed has raised the issue of its removal the hype will begin again. As an example, Randall Forsyth devoted half of his “Up and Down Wall Street” column to the issue this week. (You need a Barron’s or Wall Street Journal subscription to access).
Here’s another ditty from CNBC earlier in the week: “Why mortgages, other interest rates could go up faster than you think.”
This does not mean that the market won’t go down on any Fed move to reel in Q.E. … most people don’t read my work. It does mean, based on past experience, that it will probably not be the end of the world and may even create an opportunity. Consider this post a preemptive strike on the silliness.
What’s your take?
Average Daily Trading Volumes (billions)
| U.S. Treasury | ||||||||||||||
| Average Daily Trading Volume | ||||||||||||||
| USD Billions | ||||||||||||||
| Treasury Bills |
Treasury Inflation Index Securities
|
Floating Rate Notes
|
Coupon Securities Due in 3 Years or Less
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Coupon Securities Due in More Than 3 Years but Less Than or Equal to 6 Years
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Coupon Securities Due in More Than 6 Years but Less Than or Equal to 11 Years
|
Coupon Securities Due in More Than 11 Years
|
Total2 | |||||||
| 2002 | 43.5 | 2.4 | 131.3 | 96.8 | 79.2 | 19.3 | 372.6 | |||||||
| 2003 | 43.4 | 3.6 | 137.7 | 122.7 | 98.7 | 24.2 | 430.3 | |||||||
| 2004 | 51.0 | 6.0 | 170.5 | 134.7 | 111.0 | 24.6 | 497.8 | |||||||
| 2005 | 51.0 | 8.9 | 191.9 | 141.6 | 126.1 | 29.4 | 549.0 | |||||||
| 2006 | 33.2 | 7.8 | 200.8 | 122.8 | 116.9 | 28.0 | 509.6 | |||||||
| 2007 | 45.7 | 8.2 | 209.5 | 145.0 | 127.1 | 30.5 | 566.0 | |||||||
| 2008 | 75.4 | 8.2 | 182.8 | 151.1 | 111.4 | 28.7 | 557.5 | |||||||
| 2009 | 76.1 | 5.2 | 136.1 | 82.6 | 87.2 | 23.9 | 411.1 | |||||||
| 2010 | 76.8 | 6.4 | 163.2 | 111.2 | 134.5 | 31.8 | 523.9 | |||||||
| 2011 | 72.8 | 9.5 | 177.7 | 135.1 | 137.1 | 35.7 | 567.8 | |||||||
| 2012 | 77.9 | 10.9 | 146.7 | 118.8 | 131.7 | 34.4 | 520.3 | |||||||
| 2013 | 81.1 | 12.4 | 146.6 | 129.7 | 140.1 | 35.4 | 545.4 | |||||||
| 2014 | 65.3 | 11.4 | 152.3 | 125.8 | 117.7 | 31.6 | 504.2 | |||||||
| 2015 | 65.0 | 12.8 | 2.0 | 134.0 | 120.4 | 115.9 | 39.9 | 490.1 | ||||||
| 2016 | 84.9 | 15.4 | 3.2 | 132.6 | 121.6 | 118.2 | 38.3 | 514.2 | ||||||
| 2015 | ||||||||||||||
| Jan | 64.5 | 14.7 | 1.6 | 132.3 | 125.5 | 128.0 | 46.9 | 513.4 | ||||||
| Feb | 58.7 | 14.4 | 1.7 | 146.7 | 137.9 | 143.9 | 54.3 | 557.5 | ||||||
| Mar | 64.2 | 14.7 | 2.3 | 157.2 | 127.3 | 118.5 | 40.4 | 524.5 | ||||||
| Apr | 64.6 | 12.2 | 1.5 | 122.6 | 105.3 | 96.6 | 30.7 | 433.6 | ||||||
| May | 59.0 | 13.2 | 1.2 | 132.5 | 116.8 | 134.9 | 45.9 | 503.5 | ||||||
| Jun | 59.7 | 12.2 | 2.7 | 137.3 | 127.6 | 127.5 | 39.4 | 506.5 | ||||||
| Jul | 59.8 | 12.1 | 1.4 | 120.9 | 116.8 | 110.8 | 41.1 | 463.1 | ||||||
| Aug | 67.4 | 13.6 | 1.9 | 129.6 | 122.9 | 126.2 | 47.7 | 509.3 | ||||||
| Sep | 67.8 | 12.9 | 2.2 | 142.6 | 121.6 | 116.0 | 35.9 | 498.9 | ||||||
| Oct | 53.4 | 12.1 | 1.9 | 114.8 | 117.2 | 98.0 | 38.7 | 436.2 | ||||||
| Nov | 73.0 | 11.6 | 3.2 | 151.8 | 142.9 | 118.8 | 36.8 | 538.0 | ||||||
| Dec | 84.0 | 11.1 | 3.0 | 125.6 | 94.5 | 85.2 | 27.3 | 430.7 | ||||||
| 2016 | ||||||||||||||
| Jan | 87.3 | 14.4 | 5.2 | 154.6 | 123.1 | 119.8 | 37.0 | 541.5 | ||||||
| Feb | 80.7 | 16.7 | 3.8 | 137.5 | 139.1 | 150.6 | 45.3 | 573.8 | ||||||
| Mar | 88.7 | 16.3 | 2.4 | 124.4 | 121.6 | 115.2 | 33.4 | 501.9 | ||||||
| Apr | 67.7 | 15.4 | 3.6 | 116.4 | 114.2 | 95.1 | 31.5 | 443.9 | ||||||
| May | 70.0 | 17.0 | 4.1 | 118.7 | 109.6 | 113.6 | 37.0 | 470.0 | ||||||
| Jun | 84.5 | 13.5 | 3.0 | 132.9 | 118.8 | 123.6 | 38.3 | 514.7 | ||||||
| Jul | 80.8 | 12.7 | 3.6 | 127.1 | 111.3 | 110.3 | 40.8 | 486.6 | ||||||
| Aug | 80.8 | 14.7 | 3.1 | 129.8 | 109.7 | 110.5 | 38.4 | 487.1 | ||||||
| Sep | 88.2 | 14.2 | 1.8 | 132.4 | 112.4 | 112.1 | 38.0 | 499.0 | ||||||
| Oct | 95.1 | 14.7 | 2.9 | 147.1 | 120.7 | 100.7 | 33.8 | 515.0 | ||||||
| Nov | 100.6 | 18.5 | 2.6 | 143.0 | 161.8 | 159.3 | 50.6 | 636.4 | ||||||
| Dec | 90.8 | 17.0 | 2.2 | 127.6 | 110.6 | 98.5 | 33.0 | 479.6 | ||||||
| 2017 | ||||||||||||||
| Jan | 91.5 | 18.8 | 4.3 | 135.2 | 137.9 | 114.2 | 35.6 | 537.4 | ||||||
| Feb | 90.0 | 23.9 | 3.5 | 141.5 | 131.2 | 118.6 | 39.9 | 548.7 | ||||||
| Mar | ||||||||||||||
| Apr | ||||||||||||||
| May | ||||||||||||||
| Jun | ||||||||||||||
| Jul | ||||||||||||||
| Aug | ||||||||||||||
| Sep | ||||||||||||||
| Oct | ||||||||||||||
| Nov | ||||||||||||||
| Dec | ||||||||||||||
| 2016 YTD | 87.3 | 15.6 | 4.5 | 146.1 | 131.1 | 135.2 | 41.2 | 557.7 | ||||||
| 2017 YTD | 91.5 | 21.4 | 3.9 | 138.3 | 134.5 | 116.4 | 37.8 | 543.0 | ||||||
| % Change | 4.8% | 30.2% | -17.9% | -12.6% | 12.0% | -4.6% |
Disclaimer: The information presented in kortsessions.com represents my own opinions and does not ...
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Bill, I looked on your site too, but there is still something wrong with the chart - the headings don't line up so I'm having trouble following it.
Wendle, this any better?
What one dollar invested in 1802 would have been worth in 2012:
(total real returns -- adjusted for inflation)
• $ 704,999.00 if invested in common stock
• $ 1,778.00 if invested in bonds
• $ 281.00 if invested in t-bills
• $ 4.52 if invested in gold
• $ 0.05 if left under the mattress
(source-jeremysiegel.cocm)
Thanks for clarifying.
Good read, thanks.
If the Fed were serious about allowing inflation, wages would be higher. But allowing inflation would hurt all this bonds-as-collateral scheme. So, the Fed cares more about the bonds than about Americans making a decent wages. And this started way before NAFTA. Nice read, Bill.
Gary, thank you for your comment. The ability of the Fed to stimulate inflation or curtail it is greatly over-estimated. For example, since the bottom in 2009 Fed monetary policy has been extremely stimulative. However, it has had very little effect on inflation. I think the number one factor curbing inflation over the past two decade, has been globalization... cheap labor around the world being substituted for high priced labor in the United States. This has been extremely painful for us. We just did not have a plan to deal with it... re-training, education etc.
I guess we could have put on protective tariffs. Not only would that have been extremely inflationary but it probably would have stimulated a trade war which would've been disastrous for all. I do not fault business for moving production to those lower wage cost markets, they had to do it to compete. I also cannot fault business for automation. They had to do this to compete.
It has been great for consumers and terrible for workers. it has been why everything you buy at Walmart, for the most part, is very inexpensive.
Unless we figure out a way to bring lower skilled labor into higher paying more skilled positions, this problem will persist. On top of this, because the skilled labor market wage structure has been capped by foreign competition, the minimum wage worker in this country has been really hurt because inflation in food and energy crisis over the past 20 years has really eaten in to their scant wages.
The long-term cure is already in the works, because we are creating consuming middle classes in some of the largest population blocks in the world, China and India. It is already providing for wage pressures in China. And production in some industries is coming back on shore. On the inflation front these middle classes are going to want to live like us. This should provide dramatic increases in demand for commodities and consumer goods world wide (again, all of this will totally be out of the Fed's control).
All of this in the long run is good for the United States. Asia is minting a significant number of new potential customers. But again, this whole thing continues to be a very painful process for many while the investor class continues to make money. I wish I had a solution.
Again, thanks for the comment.
bk
Bill, I just have to add that bad inflation, the raising of tariffs, would have cost Americans. But the good inflation of prosperity is never allowed. You may be interested in the chart that shows how the Fed prunes wages in an article I just shared. I agree with you that we should be patient with China, as it is our biggest customer base, and industry from China will move back to the US. And new industry from China will likely come here too. Anyway here is the chart. The Fed is good at taking the economy down, but it creates an asymmetry: www.talkmarkets.com/.../stock-markets-fear-the-fed-more-than-war
Gary, I am not certain that I can agree with you on this. It looks to me like they are using every tool in there toolbox, extremely low interest-rate's, A tremendous amount of increase in their balance sheet and they are moving exceedingly slow when it comes to raising interest rates. Three quarters of a point off 0 to 25 basis points is a pittance. They need to get short-term rates up a little bit more so that in the event and economic shock they can move to lower them again. having lived through prosperous times with much higher rates, I can guarantee you the current moves by the Fed are not stifling growth. as it pertains to the Fed taking the economy down, it usually helps if there are big excesses in the economy. I just don't see that right now. Oh well, that's what makes horse races.
The Eurodollar market is shrinking. According to some, that impedes investment in the USA and therefore, growth. And it is seen as a tightening. I agree that going negative, nominally, is where we are headed if they don't raise rates more when there is a little prosperity. Only problem is the dollar gets stronger.